We have written a number of times about the wealth eroding effect of inflation, particularly against a background of low bank base rates. The only way, at present, to avoid the certainty of real-terms capital loss is to expose your savings to an element of risk and then of course there is no certainty that you will be successful, particularly in the short term, which is why astute wealth management is needed.
However, there is another challenge facing those who have built up pension funds to provide them with a retirement income. It is generally known that annuity rates are at the same rock-bottom levels as interest rates – this is one of the effects of the quantitative easing measures introduced by the Bank of England that have led to a fall in Gilt yields upon which annuity rates depend. However, for those with pension funds substantial enough to have made income drawdown a viable approach to retirement income provision, recent changes to the maximum allowable income calculation formula as stipulated by the Government Actuary’s Department (GAD) are combining with vastly diminished long-term gilt yields (reductions of 30%+ over the last 5 years) to create a perfect storm of challenging circumstances.
Prior to the recent change the maximum permissible drawdown income for an individual between age 55 and 75 was, rather confusingly, expressed as 120% of GAD. Under the new calculation method the maximum permissible income is 100% of GAD. In simple terms this means that someone taking a GAD maximum income of £12,000 per annum would see this reduced to £10,000 after review. This reduction is before any other factors are taken into account. When all factors are considered, including the equalisation of actuarial assumptions for men and women enforced by European gender equality legislation, it is possible that maximum income entitlement could be halved or even worse depending on the age or sex of the client.
The changes to the rules on income drawdown, officially now to be known as “capped drawdown” have also reduced the period between income level reviews from 5 to 3 years.
It is important to stress that these changes, although likely to be a source of serious inconvenience or worse to some, should not be regarded as bad news in the long term and are designed to prevent unduly rapid erosion of a pension fund so that, over time, the income withdrawal level is more likely to be sustainable.
A form of income withdrawal known as “flexible drawdown” has also been introduced. This is only available to those who satisfy the “Minimum Income Requirement” (MIR) with secure pension in excess of £20,000, not including the drawn down income. The following are considered forms of secure pension:
• State pensions;
• Lifetime annuities (including with-profits or unit-linked annuities) under registered pension schemes;
• Scheme pensions from registered pension schemes; and
• secure pensions from overseas pension schemes
Not only is drawdown income specifically excluded as a form of secure pension, so is income from investment bonds, non-registered pension schemes and, perhaps surprisingly, purchased life annuities.
The new rules will no longer compel a choice to be made at age 75 between annuity purchase and Alternatively Secured Pension (which no longer exists) although tax-free Pension Commencement Lump Sums must be drawn before age 75. The tax charge on crystallised funds on death of the member has been equalised before and after age 75 at 55%.
Those who will be most hard hit by these changes are those taking maximum GAD. If you feel that you will be affected by this more restrictive maximum GAD calculation formula and would like to talk about any concerns, please feel free to call Robert on 0121 633 7218.
24th November 2011