Today I want to talk about a big problem for your money: how it's going to work for you when you retire.
There's no doubt in my mind that pension providers are in deep trouble.
The stock market has barely budged in 15 years. Yields on their belovedgilts have fallen to practically nothing. And to top it all, punters are living too long.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Put it all together and it's getting dead expensive to provide retirees with a decent income. So it's little wonder clients can't get a decent return on their pension savings. And I can't see that changing.
Now I'm not about to suggest you cash in or stop paying into your pension plan, or to change any other provisions you have in place for retirement.
But what I will say is thatyou don't necessarily have to take this on the chin. The recent downturn in the markets has just provided a golden opportunity for you to get into one sector of the market that's mostly ignored by private investors. And it could be a great addition to your retirement plans.
With annuity rates like this, it's time to hunt for yield
Here's the way things work in the pensions game. For years and years, you save up your hard-earned cash in your pension pot. Then at some point you convert your savings into an income for life' with an annuity policy. It's the way we've been taught to do things.
But because of the reasons I've just mentioned, those policies arebarely pay out at all. At current rates, if you want an income to keep up with inflation, you're going to need a million quid just to get £30k a year. You're effectively getting 3% index linked. And if you choose to take a policy that doesn't move up alongside inflation, you'll get a straight 6% return.
But beware, when you pop your clogs, that's it, the policy terminates.
It doesn't have to be that way, though.
See also
A mate of mine put an idea to me recently a way I could get more income for my money from these pension providers. See what you think.
He suggested that rather than accepting the lousy rates offered by pension providers, investors would be better off buying the company's shares. That could be done in your regular trading account, or, to make it more tax-efficient, in a SIPP (self-invested personal pension) or an ISA.
Take Legal & General (LGEN). Like the rest of the big insurers, it offers an annuity for your average 65-year old that pays around 3% inflation linked. Not much to shout about, is it?
But if you plumped for the shares right now, you'll get over 5% dividend yield and you'd reasonably expect that return to keep up with inflation.
Of course, the problem is, we're in tough times. Stock markets are falling and the economic outlook is not positive. If life continues to be tough for L&G, then that dividend could be reduced or may not materialise at all. And the shares could come under serious pressure.
So buying shares in L&G as part of your retirement plans looks like a risky strategy to me.
But here's another option I like more.
You be the banker and pick up 7.5% per year
So we know that being a customer of these pension providers doesn't pay very well at the moment. And we've seen why buying stock in the business can be risky. But what if you become the banker' to the pension provider?
What if I told you that you can currentlylend money to L&G and get a return of nearly 8%.
Better still, you don't have to wait until you retire to get this income stream. You can start straight away. And just like the shares, you can hold it in an ISA. And unlike those pesky annuities, you can pass this on to your loved ones after you're gone.
Take a look at this chart of L&G's long-bond which runs until the end of the century.
LEGAL & GENERAL 5.875% 2099 bond
Source: Teleborsa
Five-year performance: 2006 -6.78% | 2007 -5.48% | 2008 -26.77% | 2009 +13.96% | 2010 +9.72% | 2011 (to 4 October) -16.54%
As you can see from the chart, this bond has taken a pasting over the last few months. Now it's starting to look rather interesting.
The interest rate offered on the bond when it was launched in 2004 was 5.875%. But because you can now pick up the bond for 77p, you're effectively getting an interest rate of 7.5%
Now, you may say that 7.5% on this bond isn't much more than the 6% you can get with the L&G annuity. And it's important to point out that with the annuity you'd have more protection should L&G go bust.
But that misses two vital points.
Why this could play an important part in your retirement plans
First, with the bond you can start to accrue your benefits immediately. And with interest rates stuck at practically zero, 7.5% is a great return.
But be aware, the interest rate will be re-set in 2019, and then every five years after that. The new rate will be the yield on a five-year gilt plus 2.33%.
Now I don't know where gilt yields will be in five years' time, but at least with this bond, you're set to get nearly 2.5% over the five-year gilt.
Secondly, unlike an annuity, this pay-out isn't limited to just you. Should you die, it'll pass to your heirs. And in 2099, they'll get £100 back for every £77 you invest today (of course, this is subject to all the normal inheritance tax laws).
I told you that credit crunch part II will throw up some interesting opportunities. To my mind, this is one of them. 7.5% from one of the UK's oldest insurance companies, looks like a great return.
And it's very easy to get into. The bond is traded on the London Stock Exchange, so you can buy it through your traditional stockbroker.
I'm not for a moment suggesting you alter your retirement plans. That's up to you and your financial adviser to discuss in relation to your own circumstances. But I think this could be a good place to earn a decent income on a portion of your capital, alongside any existing plans you may have.
Let me know belowwhat you think or if you've seen any other interesting ideas I should look at.
Action to take: BUY LEGAL & GENERAL 5.875% 2099 bond
ISIN: XS0189013823
Currency: UK sterling
Current price: 77p
Minimum investment: £1,000
Further details: London Stock Exchange
This article is taken from the free investment email The Right side. Sign up to The Right Side here.
Several readers pointed out that I had overlooked an important point about this bond. Rather than the 7.5% being guaranteed until 2099, the interest rate will be re-set in 2019, and then every five years after that. The new rate will be the yield on a five-year gilt plus 2.33%. I have amended the article accordingly.
Important Information
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Frank Hemsley. The Right Side is issued by MoneyWeek Ltd.
MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798. https://www.fsa.gov.uk/register/home.do
