In the second of our articles this month focusing on falling retirement incomes we look at how lower gilt yields will lead to lower incomes being available from Income Drawdown products.
The problem affects both those people already in Income Drawdown and those who are considering using it as an alternative to an Annuity purchase.
The maximum income which can be taken from an Income Drawdown plan is set by the GAD (Government Actuarial Department) tables, which take into account three things, namely, age, gender and crucially long term gilt yields.
Gilt yields have fallen during the course of 2011, consequently so has the maximum income which can be taken from an Income Drawdown plan.
There is a second problem.
It used to be the case that the maximum income which could be taken was 120% of the GAD figure, however the coalition government have changed this to 100%, giving a double blow to Income Drawdown investors.
Both these problems come at a time when inflation is rising faster than at any time over the past few years.
Lower incomes plus rising inflation, really is a toxic combination.
So, just how low are the new rates?
The GAD rate in December 2011 will hit a new low of 2.5%; it has fallen by 1% so far this year and massively from the previous high of 6.25% in 1998.
The maximum incomes available in December, assuming a fund of £100,000 will be as follows:
|Maximum income available per year at age 60||Maximum income available per year at age 65|
For the first time in many years the maximum GAD level is comparable to Annuity rates. The following table shows the most competitive Annuity rates and the difference between maximum GAD:
|Annuity income per year at age 60||Annuity income per year at age 65|
|£5,530 (Canada Life)
|£5,621 (Canada Life)
(Source: The Exchange 24th November 2011) The figures assume a joint life Annuity, with the female being three years younger than the male, a fund of £100,000, level, 10 year guarantee, 50% spouse’s pension.
Who is affected?
There are two main groups of people who are affected:
- People already in Income Drawdown The maximum level of income was previously reviewed every five years. From April 2011 this was changed to every three years for people aged below 75 and yearly above that age. Income Drawdown investors coming up to a review over the next few months could be in for quite a shock. Their income could fall over the next three years, especially if they were previously taking relatively high levels of income.
- People approaching retirement In the years leading up to retirement people may have funded their pensions to target a set income when they finish work. An Annuity rate or GAD figure will have been assumed and it is quite likely that the actual rate of income will be lower than the assumptions made, possibly leaving them short of income in retirement
The lower GAD rates might sound like complex technical issues which will only affect a handful of people, however we are seeing more and more clients affected, only this week we have seen a female client of ours whose income is likely to drop by around £12,000 per year when she reaches her next review date.
If you are already in Income Drawdown and your income will fall at the next review the most obvious thing would be to try and reduce outgoings to a level which is manageable on the lower level of income.
You could also look to take an income from your savings or investments; perhaps you have been looking for capital growth and living off your pension income. Now might be the right time to switch focus and start to draw an income from your capital.
Any cuts in expenditure or income you take from your savings or investments might only have to be a temporary measure if the GAD rate rises again in time for your next review. Although if inflation falls over the next year or so as many experts are now predicting, don’t expect a quick rise in the GAD rates.
You could also consider moving out of Income Drawdown into an alternative retirement income vehicle. As we have seen an Annuity now provides a comparable income, assuming you take a Level Annuity, to Income Drawdown. However, you are of course locking into all-time low Annuity rates, which could mean you are simply ‘jumping from the frying pan into the fire’.
There are also a range of other retirement income options, such as Fixed Term Annuities, Investment Linked Annuities and With Profits Annuities, all of which may have a part to play.
If you have not yet retired you could consider all of the measures outlined above, you could also look at delaying retirement until you have enough income to bridge any shortfall, although this is unlikely to be a popular option, it may be the only choice for some.
Advice here is essential, to ensure you make correct choices now, but also so you don’t preclude any options in the future, for example if you buy an Annuity now, you cannot move back to Income Drawdown should the maximum GAD rate rise in the future.
Despite the large falls in the GAD rates there are one or two silver linings.
With lower incomes available it should, in theory, be easier for the growth of the fund to keep up with the income being taken. Of course this is not guaranteed and Income Drawdown generally comes with more risk attached to it than other ways of generating an income in retirement, for example an Annuity.
A period of positive growth, then with lower incomes taken, might even see some growth in the size of Income Drawdown ‘pots’, which might make up for losses seen by many over the past few years.
Finally, the maximum income which you can take from an Income Drawdown plan is reviewed regularly, hopefully, the GAD rates may have risen by the time your next review comes around.
Planning for your retirement and dealing with the ‘curve balls’ which come along from time to time can be tricky.
Whether you are currently in Income Drawdown or are approaching retirement our team of Independent Financial Advisers are here to help you make the right decisions for your circumstances.