THE SWINGING SIXTIES AND SEVENTIES
How do you fancy this deal?
At age 60 you give me £100,000 and I will give you £5,800 back every year until you die. Oh, that is if you are a man. If you are a woman I will only give you £5,500.
Whilst for a lot of people Annuities are the best and only option it is not very attractive to have to wait at least seventeen years before you even get all of your original capital back is it? Sounds like a good deal for the person getting your hundred grand though wouldn't you say? The truth is this is exactly what you would get if you wanted to buy an Annuity with your pension fund at the present time. No wonder it is a struggle to encourage people to invest in pensions.
The poor value offered by Annuities is not a new phenomena as Annuity rates have been falling for the last twenty years. The fact that rates are now at record low levels means they are poorer value than ever, and one of the solutions for those able to do so was to keep your pension fund invested and draw income from it. This is commonly known as Pension Income Drawdown, and has been the most popular way for those with larger funds to take benefits since it was introduced in 1995. Since then there has been a bit of tinkering with the rules, but the main attraction has always been the ability to vary the amount of income you could take up to the maximum allowable each year which has always been higher than an Annuity could provide. Until now.
The Government, in their wisdom, reduced the maximum amount that could be taken from a pension fund in Drawdown this year by 16%. On its own this would not have been a big deal as very few people, in my experience, took anything like the maximum allowable from their pension. However, since this change we have witnessed the perfect storm of falling Gilt yields, which are used to calculate the maximum income that can be taken, and falls in the stockmarket. This means that anyone with a Drawdown plan that has had, or is due to have their new maximum income level calculated in the coming months could be in for a shock as the new maximum income figure could be up to 40% lower than when it was last calculated. Therefore, effectively, they will be unable to get more in the way of income than they would if they bought an annuity.
Now, before you all start to slit your wrists there is some good news. This year the Government also introduced a new type of Drawdown called Flexible Drawdown. Anyone who has read our articles over the years may recall we suggested this eleven years ago in an article in The Glasgow Herald, as something similar had been introduced by the Irish Government. Better late than never I suppose!
Anyway, Flexible Drawdown means that if someone has at least £20,000 of pension income that is guaranteed, i.e. from the State, a Final Salary Scheme or Annuity, they are free to do whatever they want with any pension fund they have in Drawdown (I had to put the words in bold as it is so rare in these days of the nanny state to actually be allowed to do anything without restriction). What this means is if you decide you want to take £100,000 out one year to blow as you wish you can. In fact, if you wanted to empty the fund you could do this at any time. The withdrawals made would be subject to Income Tax, but so what. For the first time ever people have an opportunity to enjoy ALL of their pension fund before they die.
Let's be honest, most, but not all people will find they spend less once they get past their mid seventies and at last they have an opportunity to tailor their pension income to reflect this. No more Government regulation telling you how much you can take out from your fund, no more insisting you buy an Annuity at 75. This is the pension equivalent of the swinging sixties, except the drugs are more likely to be for arthritis.
This brings me on to our next campaign to make pension planning more attractive.
The reason Annuity rates are linked to Gilt yields is because Gilts are used to guarantee the future income Annuities can provide. Very sensible. However, why are they used when it comes to calculating the maximum amount that can be taken as Drawdown income? What difference has the reduction in Gilt yields over the last few years had on the likelihood of the level of income taken to be sustained? Surely it would be more sensible to base these on life expectancy with predetermined percentages allowed based on your age. No doubt the boffins in the Government Actuarial Department will say it is far more complicated than that, but as this is the way you would try and determine how much income would be sustainable from any other form of investment why should pension funds be any different?
Hopefully we will see a change to Drawdown limits before the eleventh anniversary of this missive, but until then, for those able to do so, the goal is to get to £20,000 income and party on!
For and on behalf of Alan Steel Asset Management
Authorised and regulated by the Financial Services Authority
Award Winning Investment Managers