After the mini budget a couple of weeks ago the financial markets went into a tailspin, essentially due to the level of tax cuts announced and the fact the Government had not explained how they were going to pay for them.

Income yields on Government Gilts rose dramatically, meaning the cost of borrowing to the Government went up. 20 year Gilt yields rose from around 3% to 5% in a day which is pretty unusual. Conversely the capital value of a gilt investment dropped dramatically overnight which led to headlines around the World.

Normally, an increase in gilt yields is extremely good for all types of pension schemes for different reasons.

Final Salary or Defined Benefit Schemes (DB) offer a guaranteed pension at retirement with guaranteed increases in payment. When gilt yields increase the cost of providing the guaranteed income falls dramatically, so the funding positions of DB schemes improves.

As the funding position of DB schemes improves, the transfer out value falls- dramatic drops in these transfer values have been seen over the last few weeks (falling as much as 30%). As gilt yields are used in the calculation of a transfer value, higher rates means, a lower fund value is needed to buy a set level of income, thus dropping the transfer out value.

In personal pensions, SIPPs, and other money purchase pension schemes the rise in gilt yields has seen a fall in gilt fund values. This has had a negative impact on those portfolios that have these investments in them. Generally, a “Balanced” portfolio will have 40% in gilt type funds and a “Cautious” investor will typically have 70%-80% invested here. “Cautious” investors could have seen investments drop as much as 15% since the turn of the year.

Anyone in a Company Sponsored Money Purchase Scheme and are close to retirement may have opted for a phased switching mechanism in the run up to retirement. This means that you automatically switch your money into these types of investments the closer you are to retirement as these are usually seen as the safer than equities but that has not happened recently, and they are the more volatile investments.

But all the headlines in the press were talking about a £65 billion bailout of pension schemes so how does that affect your pension?

Well, this was to do with DB schemes only as it does not affect money purchase schemes. Since the last financial crisis, DB schemes have had to deal with low interest rates and therefore low gilt yields which has increased the cost of running them massively. To counter large volatile movements in gilt yields, various investment companies have designed derivative-based products that are called Liability Driven Investments (LDI’s) to smooth the running of the pension scheme and allow them more certainty to provide income for members in the future. However, these investments are very complex and they don’t work so well when markets fluctuate as much as they did last week. If you have ever watched the film The Big Short about the 2008 financial crisis you will know what I mean. If you haven’t I would highly recommend it. Anyway, as soon as yields rose outside of the parameters of these contracts, the DB schemes had to supply large cash sums to the providers of these contracts to ensure they remain in place – this is where they came unstuck! So, the contracts they had bought to smooth volatile markets, don’t work when the markets are “too” volatile.  This saw a situation where the Government had to step in to promise to buy £65BN of gilts to reduce the yields and then settle the DB market down.

In short, the yield rise affects investments in SIPPs and personal pensions where they have an allocation to gilts and fixed interest and have a negative effect DB transfer values.

But it’s not all doom and gloom… Today Legal & General have announced that annuity rates are at a 14 year high, so if you want to fix your income for life, now may be the time to do so.

As ever, discuss these issues with your Adviser and remember none of the above can be construed as advice to you individually.


Phil J McGovern FPFS

Managing Director