Drawing on your pension? Your income limit could fall from July
Falling government bond (gilt) yields have impacted annuity rates and from 1 July, it could also see investors in capped drawdown receive a lower annual income. Below we explain more on capped drawdown, how the gilt yield changes can affect income levels and what can be done.
Before the dawn of pension freedoms, workers heading into retirement typically opted for an annuity, which provided a guaranteed income for life, but the pot was ‘lost’ in most cases. Others chose pension drawdown where the balance remained invested but the monthly income/drawdown taken could vary.
Capped drawdown was the main form of drawdown prior to April 2015 and the launch of pension freedoms. It is no longer available to new retirees, but is widely used by existing retirees. In capped drawdown, investors can keep their pot invested, and draw an income flexibly, but are also limited in how much income can be withdrawn annually. This is designed to stop people exhausting their funds during their lifetime.
Each individual has their own maximum income limit set when they first went into drawdown. It’s set by the pension provider using the Government Actuary’s Department (GAD) rate calculations and it’s also based on the investor’s age, fund value and the yield from 15-year government gilts.
The individual’s limit is reviewed every three years (from the date designated to drawdown) until age 75, and annually thereafter.
As gilt yields have fallen over recent months (they have been below 2% since February 2016), earlier this year the government issued new drawdown tables to be used from 1 July. This would allow calculations to be made using gilt yields between 0% and 2%, rather than the current level of 2% first introduced in August 2012. The lower the gilt yield, the lower the annual income that those in drawdown can take from their pot. For July, the gilt yield will be 1.5%.
The calculation has two stages: firstly, the provider uses the investor’s age and the gilt yield to find the ‘GAD rate’. This is effectively an amount per £1,000, which is then multiplied by the investor’s fund value in the second stage of the calculation to provide their income limit.
The new rules mean that if the gilt yield is below 2% when an income is being calculated, the investor will get a lower GAD rate than they would have done previously.
This means they can take less out of their pension for every £1,000 than they could before.
Suffolk Life has provided the following comparisons to show how the income limit could fall based on the gilt changes:
- A 60-year old investor in a month when the gilt yield is 3% would have a GAD rate of £53 per £1,000. If their fund is worth £200,000, their income limit would be set as £15,900 (£200,000 x (53/1,000) x 150% = £15,900).
- A 60-year old investor in a month when the gilt yield is 1% would have a GAD rate of £46 per £1,000, because of the current 2% minimum rate. With a £200,000 pension, this would give them an income limit of £13,800 (£200,000 x (46/1,000) x 150% = £13,800).
- Under the new tables from 1 July, the same investor would have a rate of £40 per £1,000, giving them an income limit of £12,000 (£200,000 x (40/1,000) x 150% = £12,000).
The options for people in capped drawdown
An individual’s current pension arrangements will determine the most appropriate steps. They may need to stay in capped drawdown with a potentially lower income limit; they may be able to put further funds into the pension to increase their income or they may be able to ask the pension provider to switch to flexi-access drawdown (a comparative scheme under pension freedom).
Jessica List, pension technical manager at Suffolk Life which has around 15% of clients in capped drawdown, says: “If an investor still has funds that they haven’t put into drawdown, they may be able to put more funds into capped drawdown, which could boost their income limit.”
List explains that if people want to switch to flexi-access drawdown to take more income, they will trigger the Money Purchase Annual Allowance (MPAA). This was set at £10,000 but the government announced it would fall to £4,000 in April 2017 in order to prevent ‘inappropriate double tax relief’ (people withdrawing money from their pension pot and recycling it back in again, gaining more tax-relief on the sum). But once the snap general election was called, this policy didn’t receive royal assent as part of the Finance Bill. Currently, the MPAA hasn’t altered.
List says: “Investors will need to consider that triggering the MPAA is a one-way street. If there’s a chance of needing to save into a pension again in the future, investors should seriously consider whether the MPAA gives them enough scope to do so before deciding to switch to flexi-access drawdown and take income.”