Three-quarters of a million workers' pensions are at risk of devastating losses because the bond funds their nest eggs are invested in by their employers - without their say-so - are losing money.
Tumbling bond prices since the start of May have already wiped 5 per cent off the funds that many company pension schemes use to preserve the value of current and ex-employees' pensions from losses in the years leading up to their retirement.
A bond market sell-off, which many analysts predict is coming soon, would wipe up to a quarter off the value of these people's pensions - making them significantly poorer in retirement.
Most pension savers are unaware that if they are aged 50 or over and in a defined contribution pension scheme, a huge chunk of their pension is likely to be invested purely in bonds. Unknown to them, around 75 per cent of workplace pension schemes are automatically scooping their pension money out of risky equities, and into more defensive bond funds.
These funds, called 'lifestyle' funds, are designed to protect capital value in the years leading up to retirement, so people can get the biggest possible income from their annuity. It's a strategy that's worked well - until now.
Bond price falls should be good for annuity rates. However, there's an uncomfortable disconnect between bond yields and annuity rates, as it can take weeks or even months for rates to rise in line with big yield rises. This means you could be slapped with a double whammy of a shrivelled pension pot and a measly annuity rate if you're close to drawing your pension.
Despite lifestyle funds losing 5 per cent since early May, gruellingly, annuity rates have also fallen by 1 per cent, the latest Hargreaves Lansdown research revealed.
Andrew Tully, pensions technical director at MGM Advantage, said the mismatch is down to a "who is going to move first" attitude among rival annuity providers, as well as other factors such as increasing life expectancies suppressing rates.
Three step guide: How to protect your pension from bond losses
Step 1: The first thing you need to do is find out if your pension fund(s) are invested in bonds - or 'lifestyle' funds, as they are commonly called. If you're over 50, it's likely to be the case, but you can find this out for certain by asking your pension scheme administrator. Remember, if you have paid into a few different schemes over your life, you need to put the question to all of them, as they could all be invested differently.
Step 2: If you discover you are invested in one or more lifestyle funds, next, ask exactly what type of bonds the company has bought with your money. Broadly, there are three different types of lifestyle funds that have different levels of vulnerability to a bond market sell-off, although the asset allocation may differ slightly:
Pure government bonds (gilts)
This is the lifestyle fund most vulnerable to big losses as a result of a bond sell-off. This is because gilts are more sensitive to interest rate hikes - especially long-dated ones. If your fund has a high proportion of gilts dated 15 years or longer, you seriously need to consider moving your money.
50/50 government bonds & corporate bonds
This type of lifestyle fund carries slightly less risk of big losses than a pure gilt fund because corporate bonds are more defensive. But corporate bonds are by no means a safe place in a bond sell-off, so it is still worth considering moving your money out of this type of fund.
Pure corporate bonds
This is the best of a bad bunch when it comes to lifestyle funds when bonds are taking a battering, but you are still likely to lose money in the event of a bond sell-off, so weigh up your alternative options.
Step 3: If you've identified that your pension might be at risk, consider where else you might invest the money. You can ask your pension fund what other fund options there are within the scheme, and they can move your money within a matter of days if you give them the go ahead. Cash or money market funds are offered as alternatives by most pension schemes, and could be safer bets than bonds, although there will be virtually no returns with either. It might be tempting to inject some risk into your fund and ask for equities - but this can be risky if you're close to retirement and intending to buy an annuity. However, for employees who want to draw an income directly from their funds via drawdown in retirement, a higher allocation to equities may be suitable.
If your pension scheme doesn't offer an alternative investment option, or you simply don't like what else is on offer, you could transfer your money out of your employer's scheme and into a self invested personal pension (Sipp), where you can invest the money how you please.
This could be a particularly good idea if you have lots of pensions from previous employers, because these are the ones that rack up the highest charges - sometimes up to twice what you'd pay for the pension you're currently paying into. But if it's the pension you are paying into with your current employer that you're thinking of transferring, remember to factor in the money your employer puts into your pension every month (as you wouldn't get this if you left the scheme) as well as insurance and other benefits.
Some employers will let you transfer the money you've accrued into a Sipp while continuing to build up contributions, but others have restrictions, so ask your pension provider. You can set up a low-cost Sipp with no set-up fees and keep costs down by picking funds with reasonable TERs.
Once you've set up your Sipp, you could buy a selection of absolute return and strategic bond funds to minimise risk of losses without having too much risk. Laith Khalaf, head of corporate research at Hargreaves Lansdown, says strategic bond funds could be a smart idea as they have the flexibility to invest in foreign bonds and move in and out of different types of bonds in reaction to the market - unlike "clunky" workplace pension funds - where your investments are pretty much stuck in the mud.
