Anyone who is close to retirement will probably know that Annuity rates have dropped significantly over the past few years; during 2012 alone figures from MGM Advantage show a fall of 11.7%.
At the same time the maximum income which can be taken from an Income Drawdown plan has increased as a result of rising gilt yields and will increase by a further 20% due to a change in the Income Drawdown rules announced in the last Autumn Statement and due to be implemented by HMRC from 26th March 2013.
Effect of rising gilt yields on Income Drawdown & Annuities
The recent rise in gilt yields has affected Annuity and Income Drawdown incomes in different ways.
Towards the end of last year, the 15 year gilt yield, which is used to calculate the maximum income available from an Income Drawdown plan, known as the GAD (Government Actuary’s Department) rate, was at its minimum level of 2%. By February this will have risen by 25% to 2.5%, with the increase immediately reflected in the maximum level of income available from Income Drawdown plans commencing , or reaching their review date, in February 2013.
However, the situation is very different when we consider the effect of rising gilt yields on Annuity rates. The 15 year gilt yield fell to its lowest level of 2.04% in July 2012, at the time of writing it has bounced back to 2.64%, but over the same period Annuity rates have fallen.
We will look at why Annuity providers are not passing on the benefit of rising gilt yields to retirees in another article. However, it is clear that Income Drawdown investors have had a double boost to the maximum income they can take, whilst people buying an Annuity continue to battle against falling rates.
So, is it time for would-be retirees to consider Income Drawdown again?
Annuity v Income Drawdown: Which could give the highest income?
We should start by looking at the different levels of income you could receive from an Annuity and an Income Drawdown plan.
The following table shows the incomes available from a fund of £100,000; we’ve assumed a level, joint life Annuity has been bought, with a 10 year guarantee, a 50% spouse’s pension.
|Age||Best Annuity income||Income Drawdown: Maximum income (as at February 2012)||Income Drawdown: Maximum income (taking account of rise to 120% GAD from 26th March)|
|55||£4,278 per year||£4,400 per year||£5,280 per year|
|60||£4,767 per year||£4,900 per year||£5,880 per year|
|65||£5,250 per year||£5,600 per year||£6,720 per year|
It’s clear that following the recent rise in gilt yields there is the potential to get a higher income from Income Drawdown than from an
Annuity. The difference only increases when the changes due to take place towards the end of March are taken into account.
Whilst an Income Drawdown plan might give a higher starting income it can carry significantly more risk than an Annuity and therefore isn’t suitable for everyone.
Income Drawdown might be a suitable option for you if:
- You want a higher starting level of income than an Annuity can provide and you are prepared to accept that your income may fall in the future if investment performance isn’t sufficient to maintain the current value of your fund or if gilt yields fall in the future
- You have a relatively large pension fund, usually over £100,000, although there are occasions when Income Drawdown can be used below this level
- You want the possibility of a rising income in the future if investment performance is good enough to increase the size of your fund despite the income you are drawing
- You are prepared to accept that your income is not guaranteed and that it could rise and fall at the mandatory reviews, which must take place every three years before the age of 75 and annually thereafter
- You are prepared to accept that Income Drawdown generally involves taking more risk than the purchase of an Annuity and that depending on how your investments perform the value of your capital, and therefore income, could fall
- You want your dependents to have more options, including the ability to take a lump sum, on your death, than are available from an Annuity
- You are prepared to pay the on-going costs, for both the Income Drawdown plan and advice, if you use an adviser
- You want a solution which can be altered to reflect changes in your circumstances, for example you may wish to have flexibility in the level of income you take
An Annuity might be a suitable option for you if:
- You want to take no risk and to have a guaranteed income for the rest of your life which can never fall
- You want a relatively simple solution, which does not require regular reviews
- You are happy with the amount of income you can buy from an Annuity
- You are happy that you will not need to change the options you selected at outset
- Due to medical or lifestyle issues you qualify for an Enhanced Annuity, which will increase the level of income available to you
Are current trends likely to continue?
Choosing the right retirement income option is much more than just picking the one which pays you the highest income. Nevertheless, with inflation rising and other state benefits potentially being cut, the level of income is undeniably important.
So will the difference between the maximum available income from Annuities and Income Drawdown continue to widen?
Quite possibly in our view. Why?
Irrespective of the economic situation in the UK it is likely that gilt yields will continue to rise slowly with any increase automatically passed on in the Income Drawdown calculation. However, this isn’t the case with Annuities, with providers pointing to increased longevity, rising costs and EU legislation as reasons to keep Annuity rates low or even drop them further.
Consider all options
Just because Income Drawdown offers a higher annual income than an Annuity this doesn’t automatically mean this is the right option for you, it is certainly more complex, riskier and expensive than an Annuity.
However, the higher level of income available from Income Drawdown certainly means that for those people who are prepared to take some additional risk it should be seriously considered as an option.
It doesn’t stop there either, as well as an Annuity and Income Drawdown you should also consider other options such as Investment Linked Annuities, Fixed Term Annuities and Phased Retirement; after your house this is likely to be the biggest financial commitment you ever make, it’s vital you have considered all the options.
Our team of Independent Financial Advisers in Nottingham are experienced in developing retirement income strategies for clients the length and breadth of the UK. If you are approaching retirement and would like advice on your options call one of our IFAs today on 0115 933 8433, alternatively enquire online or email firstname.lastname@example.org