Pensions panic in face of 'perfect financial storm'

As tumbling shares, property, and risky assets combine to drag retirement funds down, the experts' advice is simple – just hang on! Kate Hughes reports

Opening your next pension statement is likely to be an uncomfortable experience. UK pension funds are facing what one analyst calls a "perfect financial storm". The big idea with pensions is that they are meant to be safer because they invest for a long time across a range of investments. Despite periods of under-performance in the past, this theory has just about held water, up until now at least.

Over the past year, pension funds have found themselves under attack, racking up big losses across a range of investments. "The problem is that nearly all assets – except government bonds – have slumped in value, even gold. It seems to be a perfect financial storm at present," says Tom McPhail from independent financial advisers Hargreaves Lansdown.

The most obvious downers for pensions are the ongoing falls in world stock markets. "UK pension funds have reduced their exposure to shares since 2000 but they still have far more invested in the stock market than pension funds on the Continent," Mr McPhail says. According to the Association of British Insurers, UK pension funds own approximately 15 per cent of shares in the FTSE.

Hedge funds are the latest asset class to have joined the comprehensive ranks that have taken a nosedive. Last week, The Independent revealed that some hedge funds had lost billions in betting that shares in Volkswagen would fall when in fact they surged strongly on news that Porsche had built a major stake. Mr McPhail estimates that anything up to 5 per cent of pension savings are invested in hedge funds. And with UK pension funds exposed to this risky asset class – as well as battered shares and property – the retirement savings pots of more than 3.7 million people who pay into money- purchase pension schemes every month have taken a huge hit. In just 12 months, the value of these funds has plummeted by nearly a third from £552bn to £395bn, according to the latest research by Aon Consulting. And that's with almost £7bn of new contributions.

"People in the UK and around the world have watched their hard-earned cash being wiped out in a matter of days," says Amanda Davidson of independent financial adviser Baigrie Davies. "Just how bad your situation is will depend on your underlying exposure to risk. If you have most of your pension fund in shares, and even corporate bonds, your fund will probably be worth less than it was this time last year, in effect making all your careful savings in the past 12 months worthless," she says.

Small fluctuations in investment performance, particularly in shares, have always been par for the course. Pension funds often recover from these dips relatively quickly. The rule of thumb is that, over time, shares – in which around 60 per cent of UK pension funds are typically invested – outperform everything else.

But for those nearing retirement, even for those with 10 years still to work before they throw in the towel, this extreme downturn – across all the major asset classes at the same time – may prove too extreme for Father Time to repair their pension pots.

"Many people may be tempted to switch their pension assets held in shares at low value and move into deposit savings accounts," warns Helen Dowsey of Aon Consulting. "But it's not a good time to do this while equity markets are falling – in effect it crystallises losses. Waiting a little longer to reduce the risk in your pension portfolio could help claw back a little of your lost funds. It will be even more essential to seek independent financial advice," she says.

In the current financial situation, IFAs urge people to think carefully about their options. Delaying the purchase of your annuity, or phasing your annuity purchase over a few years could reduce the impact of the latest dive. Even delaying retirement for a few more years could be a sensible, if unwelcome, tactic.

"It may appear a double blow to workers that not only are they facing more of a struggle to make ends meet, but the economic turmoil is also seemingly eating into the money they have been putting aside for retirement," says Ms Dowsey. "However, most workers will have time on their side as their retirement will be many years away, enough time to weather the current storm."

Mr McPhail says: "This is a significant drop, which has wiped years of savings off people's pension funds. But we have to assume that eventually the markets will recover. Those in their 20s, 30s and 40s can watch the market volatility with some detachment because they have time to wait for the market to recover."

But this is not the time to become complacent by cutting pension contributions, despite the squeeze on disposable income. "This is actually the best time to up your contributions," says Mr McPhail. "Those making regular monthly payments are buying investment units cheaply, which will increase in value as the markets recover and move forward."

"Now is the time to engage with your pension fund," adds Ms Davidson. "It is important to know what money you have and where it is invested. Think carefully about the risks you are carrying, and when you are 10 or five years from retirement consider moving your investments away from shares to safer options, like deposit savings accounts. That means that if the stockmarket takes another tumble in the future, just as you retire, you are protected."

But, long term, there is also the Government's plan for personal accounts in 2012 to add into the mix. Under this scheme, every working person who isn't already a member of an occupational pension fund will be automatically enrolled in a scheme which saves a percentage of their salary every month. Anyone who doesn't wish to take part would have to actively opt out of the scheme. Most pension specialists believe that any scheme which encourages us to become a nation of savers is a positive move. But there is some concern that the blanket scheme could backfire, Mr McPhail warns. "Companies already paying into other schemes could easily use the new plans as an excuse to reassess their pension provisions and reduce the amount they pay for their employees' retirement."

Meanwhile, final-salary pension schemes are also taking a hit in the storm. Aon says the 200 largest final-salary schemes – outside the public sector – are running a combined deficit of £15bn. And payouts are increasing because life expectancy is going up and so members are drawing more money.

People with a final-salary scheme through a public-sector employer are safe – because the tax payer ultimately pays for their pensions – but if a private company goes bust it has to call on the Pension Protection Fund (PPF) to cover its pension liabilities. If the company goes under and the pension scheme attached to it is found to be in deficit, the PPF will step in to pay 100 per cent of your retirement income if you have already begun drawing your pension, and 90 per cent of your expected income if you are still working (up to a maximum £27,800 a year).

But as the recession hits and more companies go bust, the PPF, to be able to pay out, will have to increase its levies. This will increase the cost to scheme providers, in a time of recession. Final-salary trustees may ask for as much as £45bn extra a year for the next five years from scheme members and employers, Aon calculates.

Final-salary schemes have been on the wane for years. It costs companies the equivalent of 25 per cent of each individual's salary to maintain a final-salary scheme, Hargreaves Lansdown estimates, and for some that is just too much. Four-fifths of final-salary schemes are closed to new members and the rest may batten the hatches in the face of this perfect financial storm.