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The Value of Your Investments Can Go Down
by Andrew Verity
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Tumbling stock markets are having a devastating impact on the retirement plans of thousands of people who hope to draw on private pensions in the near future, forcing many to put off their plans.
With shares worth nearly a third less than they were at the start of the year 2000, pension funds, endowment mortgages and bonds have all been hit hard.
Most life insurers have already imposed exit penalties for people wanting to cash in endowments and savings policies early. Depending on the life insurer they invest with, customers will lose up to 10 per cent of their policy's value if they cash it in before its maturity date.
Many major life insurers have also cut the value of most of their clients' policies in absolute terms - no matter when they draw out their money. Friends Provident has slashed them by 7.5 per cent. CGNU, which includes Commercial Union, General Accident and Norwich Union, has cut policy values by 5 per cent.
As these are long term investments, financial advisers are telling most clients to sit tight and wait for a stock market upturn which may restore the value of their policies.
However, there's an immediate impact on those planning to retire in the immediate future with income from a private pension fund.
When people retire on a private pension, they use the fund they have built to buy an annuity - a financial vehicle that pays them an income until death.
How high that income is depends on two factors - how big the fund is and what rate the annuity will pay.
Because both of those factors are unfavourable at the moment, people about to retire have been hit twice.
At the start of the year 2,000, a 65-year-old man retiring with a fund of 拢100,000 could get an annuity which paid 拢9,065 a year. The same 拢100,000 fund today would buy an annuity of 拢8,913, according to figures from The Bureaux, a specialist firm of financial advisers.
But his fund would be invested largely in shares and so would have shrunk. A 20 per cent fall in the value of a fund would reduce the income he could buy by nearly 拢2,000, to 拢7,130. If the fund fell in value in line with the market, the income he could get would be reduced to 拢6,239 - barely two thirds what it would have been in early 2000.
Independent experts say many clients are choosing to continue to work where they can. Those who must retire now might want to reduce the impact of the stock market down-turn.
One option is to use only part of the pension fund now and leave the rest in the fund, to be drawn on later (known as "phased retirement"). An investor with a 拢100,000 fund might use only 拢20,000 to buy an annuity now, leaving 拢80,000 to be invested in the hope of a subsequent up-turn in the stockmarket.
Many investors are also worried about the performance of their endowment policies, where most of the money is invested in shares. The overwhelming advice is - avoid cashing them in. Even if they appear to have performed poorly, endowments are much better value if contributions are maintained to the end of the policy. If the policy is cashed in early, the exit penalties listed above will further diminish its value.
However, there will be further worries for those who are relying on their endowment policy - largely invested in shares - to pay off their mortgage.
There are six million holders of endowment mortgages. More than half already face the risk that their endowment will be worth less, when it matures, than the original mortgage loan it is meant to pay off. Such a "mortgage shortfall" could leave them having to find the extra money elsewhere, or else face repossession.
The longer the stock market decline continues, and the deeper it is, the greater that risk. Worried homeowners have several options to ensure their loan is repaid.
One is to convert part of the mortgage to a repayment basis, so there is less capital to pay off when the mortgage matures. Because contributions to the endowment should be maintained, monthly payments will rise.
Another option is to put extra money in an alternative investment, such as an Individual Savings Account invested in shares.
Those who fear redundancy can take some measures to shore up their finances. Millions of homeowners are still paying mortgages with high variable interest rates of more than 6.5 per cent. They can reduce that by a whole percentage point - a typical saving of around 拢50 a month - by converting it to a fixed-rate loan.
For those with some equity in their home, outstanding debts with high interest rates can be consolidated by re-mortgaging for a larger amount. That can save a fortune on interest because mortgage interest rates are so low. Re-mortgaging is much easier for those still in work.
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