Income drawdown changes: Drawdown on the up

The positive introduction of capped and flexible drawdown in April 2011 has been largely eclipsed by continually low Gad rates and the unexpected lowering of the maximum income limit from 120 per cent to 100 per cent of Gad. The latter proved to be poorly thought through and has now been reversed back to 120 per cent again.

The end results risk reduced confidence in drawdown and retirement saving, but it is worth looking at these recent events in more detail to predict the future for drawdown.

A brief history of Gad rates

Gad rates have been on a downward trend for a number of years. This was accelerated by the government’s quantitative easing programme, which prompted HMRC to introduce a minimum ‘collar’ of 2 per cent Gad. Rates subsequently hit this collar in August 2012. There’s little comfort to be gained in knowing that annuity rates have followed the same trend, as shown in Graph 1, although not to the same extent.

But the numbers do not tell the individual stories of the clients behind them. Even with investment performance keeping pace with inflation, drawdown users at a five-year review in 2012 would have seen their incomes drop by more than 40 per cent. Erratic investment performance and changing Gad rates could be explained if not expected, but the legislative change lowering to 100 per cent Gad was unforeseen.

A perfect example of the growing complexity of our pension system was illustrated by the decision to restore the Gad maximum income limit to 120 per cent. As implemented, the very clients who needed the reversal the most – those who had already crystallised into the 100 per cent Gad regime – were unable to benefit from the reversal until their income anniversary up to a year later.

Right to increase?

In implementing a return to the 120 per cent regime, advisers might well have been surprised that providers did not take a consistent approach. The majority of providers decided they would maintain the existing income level, for example a client taking 100 per cent of their income limit would continue to be paid 100 per cent, even though their new entitlement was increased to 120 per cent. However, a significant minority took the opposite view and faced some criticism in doing so. They took the decision to move any client taking maximum income under the lower limit onto the maximum income under the new, higher limit.

Although the pros and cons of either approach can be debated, there’s no doubt that different approaches amid a period of significant change has led to some confusion among both advisers and their clients. This has not helped restore confidence in drawdown.

While Sipp operators continue to experience significant change, it seems the rules for drawdown have now completed their growing pains, allowing advisers and their clients a period of stability desperately needed in order to plan ahead. That has come just in time, as the UK is entering a highly significant demographic shift.

The drawdown opportunity

The baby-boomer generation has finally started to reach retirement age, with more than 800,000 people enjoying their 66th birthday this year. Hundreds of thousands of retirees, often accompanied by significant pension savings, will require advice on how to plan their retirement.

The sheer number of baby boomers isn’t the only difference; they also have greatly improved mortality rates. Today there are around 464,000 pensioners aged 75 but over the next 10 years their number is expected to swell by more than 50 per cent.

While the focus is on drawdown, it will not have escaped advisers’ attention that there is also a huge swell of population peaking at around age 45. They will need advice on their retirement just as much; with 20 years or less accumulation remaining, they are likely to have much poorer retirement provision than their parents.

Flexible, not feckless

The return to maximum 120 per cent Gad income limit returns a very useful tool to advisers for their clients. There is a false impression that drawdown investors take the maximum income possible, yet the evidence is that very few do so. In fact, there are probably more drawdown investors taking no income at all than those drawing their maximum.

Flexible drawdown’s unlimited withdrawal backed by other minimum levels of secure income has, to some extent, shown the way for capped drawdown to follow. Advisers will have different views on a recommended level of income to be drawn but there is a constant in all but a handful of cases – it is below the maximum. Planning ahead for income well below the maximum encourages a higher level of saving. It also allows for far greater flexibility to take larger one-off withdrawals on demand in the future.

More than income

For all the flexibility afforded to income withdrawal, it is the other features of drawdown that are likely to be of equal appeal to the drawdown clients of tomorrow. They are often taken for granted, yet with increasing life expectancy they should be anything but:

• Remaining invested for longer. Although there are attractions to crystallising a retirement position, it is increasingly disingenuous to completely de-risk a retirement that could last two or more decades.

• Remaining uncrystallised for longer. At least up to the age of 75, the ability to pass uncrystallised funds free of tax on death is extremely valuable.

• Passing on the fund to a spouse, or not. Bypassing a spouse is becoming an increasingly important feature of how drawdown is used.

• A need for ongoing service. The opportunity for advisers to continue to add value to their clients’ retirement in the decumulation phase.

After a period of change and uncertainty it is important not to overlook the core, well-established reasons that make drawdown a solution increasingly adopted by advisers and clients. The rapidly increasing size of the at-retirement market only adds to an opportunity that cannot be ignored.

Greg Kingston is head of marketing at Suffolk Life