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How interest rate increases help pensioners

How will pensioners benefit from interest rate rises

So the Bank of England finally bit the bullet and raised interest rates – or at least the base rate which is the basis for many other interest charges. Much has been written about the effect on mortgage rates, but what about some of the other consequences for pensioners and retired folk?

First of all the rate rise was hardly dramatic. 0.25% brought the rate back to what it was before the EU referendum, and even then it was at an all time low of 0.5%. Compared to base rates from 5% and all the way up to 12% experienced by mortgage borrowers under previous chancellors, loan rates of 3-4% on offer now are hardly punitive.

On 2 November the Bank of England signalled a further rate rise of 0.25% so even after an increase of 0.5% over the year a base rate of less than 1% would be low compared to historical rates.

Pensioners have suffered the most from low interest rates as their savings in deposit accounts have dwindled in real terms for far too long. With inflation running at close to 3% (and over 4% for every day items), the paltry savings rates on offer are far below what is required to keep pace with rising prices. However, maybe pensioners and retired folk will enjoy some hidden benefits from even a small rate rise.

If you are retired and drawing down a defined benefit or final salary pension you would have been right to be nervous about the huge pension fund deficits of many large employers. Notoriously the BHS pension scheme was bust last year until the previous owner was pressured into repaying over £360 million into the scheme, in a complicated arrangement with the Pensions Regulator.

However, even a 0.25% rate rise can have a dramatic effect on the fortunes of pension fund investment pots, a very large proportion of which is held in so-called long dated government and corporate bonds. These investments are ultra-safe, but carry low yields, so any increase in base rates can have a dramatic effect.

Many of the largest pension funds have been running at substantial deficits over the last few years. This means in effect that the value of the fund is not sufficient to meet expected future payouts. The combined deficit of the largest 350 quoted companies had soared to a massive £160 billion by August last year, a huge risk to pensioners.

City analysts are now forecasting that another quarter percent increase in base rates could bring the deficit down to £12 billion, and other trends could even bring these funds back into overall surplus.

So, good news for retired folk lucky enough to benefit from a company pension scheme then.

But the benefits do not stop there. Eliminate the pension scheme deficits and companies will deliver more profit, resulting in higher share prices and increased dividend payouts.  This will benefit pensioners across the board, whether their pot has been invested in tracker funds or a managed scheme.

Of course investors should also see a small increase in deposit interest rates, although some banks and institutions seem reluctant to pass on the benefit to their long suffering customers.

A modest increase in bank and mortgage borrowing costs, but a substantial bonus for pensioners and retired investors in investment funds.  Overall, retired folk will have done well from the Bank of England’s new appetite for base rate increases.

And BHS pensioners can sleep more easily now their pension fund has moved into an estimated £100 surplus.

Find out more about retirement income and pensions or return to our home page for more articles and features.

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