Pensions: What should you do about impending annuity review?

5th September 2011

Under income drawdown, pensioners generally leave money they have saved for a pension still invested beyond their retirement.

They usually take a pension income from their investment pot, but hope that additional investment growth, will allow them to take a higher income during their retirement, than they would have received if they had simply converted their assets into an annuity.

It is usually recommended to those who have saved substantial pension pots of several hundred thousand pounds.

However drawdown investors face three big pressures.

First drawdown pots will probably have suffered given the very difficult year for stock markets.

With drawdown plans, it is usually hoped that market growth will go a long towards compensating for the income pensioners are taking out.

But steeply falling markets can erode capital very quickly, particularly if pensioners continue to withdraw the full allowable amount every month.

Second the amount you can take from pension pot is limited by the Government using a calculation based on a rate set by the Government Actuary's Department.

This is roughly based on the 15 year gilt yield – currently below 3.5 per cent. When many pensioners opted for drawdown, the rates could have been above 5 per cent.

Most drawdown plans currently in force must be reviewed every five years under rules set by the previous Government and thousands of plans are due for review soon.

These reviews could spell bad news.

The Government has also cut the amount you can take from your pot if your drawdown falls into the new ‘capped drawdown' category.  

There is slightly better news for those who demonstrate they have a large income from other sources as they may qualify for flexible drawdown and they can actually take as much from their pension as they want.

But for most, in capped drawdown, they can now take 100 per cent, not the previous 120 per cent of GAD.

This is all very complicated but in summary, you will be able to take a smaller percentage of a smaller percentage of what is probably a smaller pot of money.

The bite this takes out of pensioners' income could be substantial.

Investors Chronicle gives the example of a reader who will lose over half their income.

He tells them "I currently draw down the maximum annual amount from my pension and the last GAD review was in March 2007, which calculated a maximum income of £26,724 per annum. The next review is due in March 2012 and if the new GAD calculation at that point reflects current low annuity rates, I will be subject to a substantial drop in income. This effect will be compounded by the new rules which only allow maximum income at 100 per cent rather than the previous 120 per cent level. I calculate that this will result in a drop in my annual gross income from £26,724 to around £12,500. That is a loss in income of over £14,000."

The irony is that when the Coalition came to power one of its first actions was to reform income drawdown in a move that was supposedly a liberalisation.

Before George Osborne's first budget, anyone in income drawdown had to convert their drawdown pot into an annuity at the age of 75 or their pension pot would be regarded as an alternatively secured pension.

This ASP was subject to huge taxes on death – at worst it could have been hit by a tax of over 80 per cent. This frustrated many pensioners who wanted to pass on their savings to their dependents.

However while the reform was touted as a liberalisation, the decrease in the GAD rate actually tightened things up and could make the reforms very unpopular.

The Government would probably argue that all it is trying to do is make sure people do not run out cash and end up relying on the state and possibly in poverty.

Indeed some pension providers have already warned the Government that even these reforms risk seeing pensioners running out of money.

Trade website Money Marketing reports that insurer Partnership has sent calculations to the Treasury warning that pensioners could run out of money.

However that will not stop pensioners complaining if they experience a huge drop in income now.

More:

Pensions: How to age proof yours

Get advice–  Find an independent pensions adviser.

Budget – work out what you need to support yourself in retirement using the Money Advice Service's budget planner.

Further reading:

Pensions: Is the government doing a Brown

The Pensions Advisory Service also has some information as has the website of the Government created pension scheme Nest.

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