The rule of 6 – why high mortgage rates spell good news for pension pots!

Six – is a tragic number.

Yesterday , the press decided to introduce a new number to the national consciousness. The number 6. It it the interest rate that mortgage payers will have to pay for a two year fix on their mortgage and it is up to three times the amount that some people have been paying to recently.

It is a bad news number and it will have many people reaching for their calculators to work out how much more they will be paying on their mortgage when the Bank of England increases interest rates again and again over the coming months. 6 is a tragic number.

What will it mean to pension pots?

If you go down to the woods today and consult with a good annuity broker (Retirement Line) , you may also hear the number. 6% is the rate a 60 year old can get for a joint life annuity

Annuity rates have risen, but not as fast as mortgage rates and that’s because of a lot of the annuity rate is based on what is going on with interest rates a lot further than 2 years out.

But the quoted 6% rate is still over 50% higher than the rate you could have got in December 2021. So if you are nursing a 30% loss on your pot last year, all is not lost.

This is all about the future cost of a pension, the same equation that means that your defined benefit pension scheme is now better funded than ever- despite it losing assets in 2022.

If you are about to take a big decision about a  pension , you should be aware that though you probably have a lot less in your pot, what you have will buy you a lot more. Put another way – is your pot down more than 50%?

The rule of 4

The rule of 4 says that a prudent drawdown rate is 4% of the amount in the pot. You can see from today’s tables that a 60 year old can get a guaranteed pension increasing at 3% pa on a joint life basis paying 4% of the pot swapped for a wage for life.

If you thought that 4% on your drawdown was an ok deal, you might like to think about swapping for a similar rate on a partially inflation protected annuity where your money is guaranteed not to run out. In my opinion – the rule of 4 applies to guaranteed annuities right now and will continue to do so, so long as interest rates remain high (at least for the next two years).

The challenge for drawdown (and CDC)

For a long time drawdown seemed a no-brainer. You didn’t need much va-va-voom in your investment portfolio to get the return needed to meet a drawdown of 4% and many people have been taking twice that and still keeping the principal in place (until 2022 that is).

But now things aren’t looking so great for investments , especially investments in the gilts market This diagram is taken from a wholesale investment article but the question it asks is as appropriate to IFAs and DIY drawdown management as to the posh “fiduciary management of DB pension schemes”.

Source Barnett Waddingham Fiduciary Management Review

Many DC default funds are constructed on the lines of DB plans (still assuming there is a guaranteed annuity to be bought. They invest like a DB fund – trying to hedge high inflation/interest rates through index linked and long dated fixed interest gilts. The result is the pain you may see when you review your DC pension pot(s)

But it isn’t all bad news. The cost of providing a pension from a pot is plummeting because of the decreasing cost of buying gilts and because the rate of increase in life expectancy is slowing and for some groups our life expectancy is actually falling.

So , as defined benefit pensions are finding out, it’s currently easier providing a pension – even if scheme assets have sunk like a stone.

Even if your pot is down – your potential pension could be up – and the good news is that your choices of pension are likely to get better.

Could we have a rule of 6 for pensions?

Some people say that the long term return needed from pension scheme assets is 6% pa. This is the contractual accrual rate promoted by Con Keating.

Adrian Boulding, when talking about the kind of drawdown you can expect from CDC in decumulation is equivalent to the cost of a level annuity (which we’ve established is around 6%).

But I suspect that most prudent actuaries (as Adrian is) would stick with the rule of 4 right now and hold out the prospect of better indexation at a time of high inflation – on the basis that any investment strategy should see inflation plus returns as a target – if inflation/interest rates run at 6% + then there should be excess returns on a CDC or drawdown to give inflation linked protection to income.

So think the rule of 4 + inflation linked returns and you get to where most actuaries are with CDC rate targeting.  I think that’s the best way of explaining CDC and the risk/reward trade off between investment and guaranteed income. And of course Adrian plans to provide you with the kind of lifetime income protection you expect from an annuity – the major advantage over drawdown.

In my opinion, a CDC pension looks a great halfway house between annuity and drawdown, offering more reward for risk taken and insurance against living too long. I can’t wait till these new CDC’s arrive and I’m keen to test them out using Agewage modelling.

Making pension numbers as easy as mortgage numbers.

We need easier ways to think about pensions. We need to be able to understand the pension rate relative to the mortgage rate and to work out what reward you could expect for investing rather than buying guarantees.

People need simple rules and journalists know it. That’s why we had so much noise yesterday when the banks announced 6% two year fixed rates.

If pensions are smart, they should be getting people to start thinking about pot to pension rates in the same way. We can think two or even five years into the future but we have trouble fixing anything much longer than that. We can think of the pensions arising from our pots with the certainty of our mortgages (many of which are variable).

In short, we can think of pensions as the opposite of mortgages and take some hope , if we are in later life, that while our housing costs are increasing, our pension power is too.

Not much consolation for those who have bought annuities prior to the current increases, but how many of us want a fixed rate for the rest of our lives? Some do – but most of us are prepared to accept a variable rate for the longer term- why is why drawdown and CDC will continue to be the mainstream of pension provision.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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3 Responses to The rule of 6 – why high mortgage rates spell good news for pension pots!

  1. byronmckeeby says:

    I’ll raise your 6 with my 72.

    Applying the rule of 72 to your 6 means that investments could double in value in approx. 12 years, with emphasis on the “could”.

  2. Adrian Boulding says:

    Thanks for the kind words Henry.
    I will be talking at tomorrow’s PMI Pensions Aspects Live event on Decumulation CDC – What it is and why it produces better outcomes

  3. Mark Meldon says:

    Henry, have you considered the implications of long-term guaranteed periods on annuities? Where you can always get back more than the purchase price, dead or alive?

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