Changing perspectives – how interest rate dynamics impact wealth planning

The Bank of England has reduced its base rate by 0.25 having held rates at a 16-year high of 5.25 per cent since August last year. Despite this move, the feeling  among economists is that further significant reductions will only materialise in the medium term. The reality of interest rates staying higher for longer is having powerful ripple effects across the economy; not least in the arena of wealth planning, where investment options and retirement choices are directly impacted. Jonathan Brown, Chartered Financial Planner at Isio Wealth Planning, explains why it matters.

It was only in June 2024 that the UK inflation rate met the Government’s target level of 2% and, although it will be seen as a major milestone in the economic travails of the past three years, it is not guaranteed to prompt continued rate cuts from the Bank of England over the coming months. Some members of the Bank’s Monetary Policy Committee hold concerns that underlying price pressures remain high, and that July’s inflation rate rise could be repeated later in the year.

With interest rates likely to remain at higher levels for longer, there are several considerations for those planning their wealth and those making retirement choices. For those individuals at the wealth-creation stage of life – what we call the “accumulators” – a higher interest rate environment presents challenges and opportunities in equal measure.

The first consideration is simply making sure you have bank accounts that pay a decent level of interest. Cash rates had already started to come down a little in preparation for central bank cuts, but whilst the interest rates on offer are still relatively high, it might be a good time to investigate fixed rate deposit accounts. The corollary of that, of course, is needing to complete self-assessment tax returns and paying the tax on the interest generated on such accounts.

Making the most of allowances

Your overall tax position can be improved by ensuring that you are making the most of your annual allowances. Simple things like moving money into an ISA for the tax year or switching money with your spouse depending on who is the higher earner, can ensure you are reducing your tax liabilities.

The higher rate of interest has also made many rethink their investment strategies. We’ve certainly seen some reticence to top-up stocks and shares ISAs over the past year, with many clients opting to hold it as cash. Whilst that position is understandable in a higher interest rate environment, the risk is that that they may miss out on some quite sizable returns.

Navigating higher costs

Of course, higher interest rates also increase the cost of borrowing, and for those at the accumulation stage, this might dramatically impact the amount of available cash to save and invest.

Today’s average homebuyer is more highly leveraged than previous generational cohorts (buying a house today requires 8.8x salary, an income-to-house-price ratio more than twice as high as it was in the 1970s). This dynamic may already impact the availability of spare cash for pension contributions and wider retirement savings, but higher mortgage rates could place a further squeeze on financial options.

In an attempt to better manage monthly costs, there has been a recent surge in younger home buyers taking out ultra-long mortgages. In the final quarter of 2023, 91,394 of new mortgages (42%) had terms going beyond the state pension age. Just over a third of these were issued to people aged between 30 and 39.

All of these trends – longer-term mortgages, higher costs of borrowing and the reduced availability of cash for savings – may translate into the prospect of lower retirement pots and the need to work for longer. 

Impacting retirement options

For those approaching retirement age with mortgage debt outstanding, higher interest rates also present a challenge. Some may be considering accessing a portion of their tax-free cash from their pension to help clear some of their mortgage burden, whilst others may be recalibrating their retirement income needs because the cost of servicing their mortgage has substantially increased.

We’ve also seen a number of clients with larger mortgages, who may have been planning on equity release, be challenged by the mortgage rate environment. Whereas at one point you could lock in and get rates for life at 3.5%, that’s now gone and – according to the Equity Release Council’s data – you’re now potentially paying over 6% on average for equity release. 

The period of high inflation and higher interest rates can also have a profound impact on other retirement choices. Cash flow modelling – a core component in projecting the income flows that different assets could generate compared with a client’s estimated retirement needs – is built on assumptions of inflation rates. When the inflation rates change, so does the model. 

The wider cost-of-living dynamic has also fundamentally shifted the expenditure patterns on which retirement plans are made. What was right two years ago is probably no longer viable. Clients will need to look at their monthly expenses now and ask whether changes need to be made – whether that’s cutting back on holidays or eliminating some other areas of discretionary spend.

The importance of education

Wherever you are in your wealth planning journey, the importance of understanding your options is of paramount importance. When I sit down with a new client, I explain that one of my jobs is to provide education to help them make informed decisions. That education doesn’t stop after the first meeting. It’s a continued dialogue because markets change; interest rates change; pension tax legislation is always changing. For many, the best wealth planning is enhanced by regular reviews – re-assessing circumstances, goals, concerns and the impact of economic and regulatory changes. A proper in-depth discussion that is of value to you. It’s based on an understanding of how market cycles work and the importance of making informed decisions throughout them, but also being very conscious of your client’s emotional ties and their own personal goals.

Throughout lifetime wealth planning, things will happen that can reshape your needs and the viability of your goals. When that happens, there is huge value in having someone by your side – a calm, stable, consistent and well-informed adviser to walk you through the process and make sure the right decisions are made at the right time.

This communication has been compiled by Isio Wealth Planning (IWP) as a general information summary and is based on its understanding of events as at the date of publication, which may be subject to change. It is not to be relied upon for investment or financial decisions and is not a substitute for professional advice (including for legal, investment or tax advice) on specific circumstances. IWP accepts no liability for errors or omissions or reliance on any statement or opinion. Where we have relied upon data provided by third parties, reasonable care has been taken to assess its accuracy however we provide no guarantee and accept no liability in respect of any errors made by any third party.