Special Features

‘Lower for longer’ interest rates - where will retirement income come from now?

Steve Hunter | Seneca Investment Managers
23rd December 2020
Steve Hunter
"The environment should certainly be prompting advisers and their clients to re-examine their investment portfolios and asset allocation."

Monetary policy by the Bank of England appears to indicate interest rates being lower for longer. Rates are nominally lower than they were 30 years ago because of a long-term decline in inflation, but they are also lower in real terms. The pandemic and its impact on the global economy has made the dilemma more acute.

Lower interest rates are helpful in getting the business world back on its feet, as a lower cost of capital allows companies to operate more cost-effectively. However, it is less helpful to those dependent on an income in their retirement years. It makes funding existing liabilities tougher for defined benefit scheme sponsors and results in lower returns on investments for defined contribution savers (the lion’s share of employees today).

While our day-to-day lives may look very different due to the pandemic, at some point in the not too distant future, we will all begin to move back to a level of normality. Due to a potential decrease in day-to-day spending, the long-term impact for those living on retirement income is yet to be fully revealed and it is worthy of further consideration.

The retirement advice market has seen a move away from annuities in recent years, with many clients wanting increased flexibility in their retirement option since the pension freedoms announcement of 2014. As a result, many of those retiring in the last five years are heavily reliant on investment portfolios to fund their retirement.

Income requirements are obviously unique to every client, but rule of thumb calculations have shown that an income of 4% per annum is potentially a sustainable expectation. With the investment markets of the last few years, investors have generally not struggled to reach and in many cases exceed this expectation.

However, things may have changed in 2020, with the pandemic impacting investment portfolios not only in capital value but also in the generation of income. It is this impact that may be felt for a longer period by those retirees. The environment should certainly be prompting advisers and their clients to re-examine their investment portfolios and asset allocation.

Many individuals of course look to dividends for income in retirement and as interest rates have remained low, many investors have sought more healthy levels of returns from equity markets. It is this source that may be most eroded as some companies delay or cancel their dividend payments in a bid to bolster their own financial stability in the short term.

Although reducing retirement income levels may not be that palatable, it is a real choice. However, are there other potential options to consider whilst remaining within an investor’s tolerance for risk?

Equity markets are potentially offering incredible value for investors right now and over time will continue to recover, so abandoning them completely is perhaps not the best course of action. However, complementing them with other opportunities could be a way forward.

A multi-asset approach has seen some investors look more widely than traditional equity sources with the inclusion of bonds, property, infrastructure, private equity and other alternatives as a means to broaden the scope for income generation.

Although not totally immune to the market effects, those who have broadened their sources of investment income are now potentially seeing the true benefits of income diversification in what looks like an increasingly dovish mid-term future, according to the Monetary Policy Committee.

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