Personal Finance: The pension problem that won't go away

LAST week's 0.5 per cent drop in interest rates is welcome news for home owners paying standard interest rates and for anyone looking for a new fixed-rate mortgage. On the downside, we'll get less interest on savings.

But there is a much more serious problem with low interest rates. And it hits us when we are most vulnerable - in retirement. A low interest rate climate means many people coming up to retirement will have far less to live on than they'd expected.

But this isn't just a problem for older people: interest rates are likely to go much lower in the next few years, so it's time for everyone to take notice of this threat. Most workers no longer have access to a generous company pension that will pay out a retirement income equal to two-thirds of their working salary after 20 years' service.

Instead, many of us have to pay into our own pension fund - either through our employer or as a personal pension - which grows (we hope) into a decent lump sum. After retiring, most people can't afford to live off their invested capital, so they sell the pension fund and buy a contract to provide an annual income, called an annuity. The rule of thumb used to be that each pounds 100,000 of pension fund could be swapped for about pounds 10,000 per year.

But we are living longer - which means less cash each year in retirement. And annuity prices are directly linked to both interest rates and the income from bonds issued by the Government (called gilts). A low interest rate means investors also get a low income from gilts.

A pensions specialist, Teather & Greenwood, estimates that a 65-year- old man with a substantial pension fund of pounds 300,000 will now get just pounds 21,000 a year (net of basic rate tax) or less than pounds 17,000 for a 40 per cent taxpayer (this example is for an annuity contract with a five-year guarantee, and no annual increase in income).

A man aged 65 buying an annuity today would need a fund 32 per cent larger than he would have needed in mid-1994 to buy the same level of income.

What's being done about this long-term, potentially devastating problem? Nothing. Most pension providers and the Government are simply ignoring it in the hope it will go away. It won't.

i.berwick@independent.co.uk