Thousands of pension investors face income drop

Thousands of pension investors face significant drops in their retirement income as tough economic conditions, market volatility and government reforms have reduced the amounts that can be drawn from a fund under ‘capped drawdown’.

This “triple whammy” is being felt most acutely by people who have been in income drawdown from their pensions for some time, but are coming up to a five-year review. For some of them, annual pension income is forecast to drop by 20-45 per cent.

Reductions in drawdown income stem from unprecedented changes to the factors that influence how much an investor can draw annually.

In April this year, the annual maximum withdrawal limit was lowered from 120 per cent of an equivalent annuity to 100 per cent of that annuity. This change was made because investors also gained the right to remain in drawdown for the rest of their lives, rather than just to age 75.

Alongside this reduction, the annuity rates used by drawdown scheme operators to determine the maximum income permitted – as specified in the Government Actuary’s Department (GAD) tables – became less generous to reflect rising life expectancy.

But perhaps the biggest headache for new and existing investors has been the yield on UK givernment bonds, or gilts, which is used to determine income levels alongside age, gender and fund size.

Since mid February, the yield on the gilt index has dropped from 4.35 per cent to closer to 3.5 per cent today, as investors seeking a safe haven investment have pushed up gilt prices.

This drop in the index equates to a £1,600 fall in annual income for a 65-year-old man with £200,000 pension fund who goes into drawdown now, rather than back in February.

“For those approaching retirement this year, the combination of falling gilt yields, the amended tables and the new lower percentage limit will mean a reduction of several thousand pounds in their annual pension income,” warns Billy Mackay, marketing director with AJ Bell, a drawdown provider. “With some commentators forecasting gilt yields to drop as low as 2.75 per cent by next year, the government should consider restoring the 120 per cent limit to avoid creating hardship for pensioners.”

Investors likely to suffer the biggest drop in income are those who are taking the maximum 120 per cent of annuity income from their funds, while also seeing their funds fall in value due to market volatility.

“My gut feeling is that a client invested heavily in equities and drawing GAD maximum for the last five years will see a fall of around 45 per cent,” says John Lawson, head of pensions with Standard Life, the pension provider. For this reason, he also supports the reinstatement of the 120 per cent income maximum.

However, the Treasury said this week that a return to the 120 per cent limit was “not being considered at present”. According to a spokesperson, the government is aiming to strike a balance between allowing greater flexibility and limiting individual risk.

How to limit a pension income squeeze

Individuals who have at least £20,000 in secure pension income, in addition to their drawdown funds, could avoid income limits completely by moving into flexible drawdown.

If this is not feasible, then capped drawdown investors who have concerns about gilt rates continuing to fall could ask for their income review to be brought forward. However, a review now could lock into a lower maximum income than currently available.

“If you do want the maximum income, the most sensible strategy is to have some of your money in a level annuity and some in drawdown,” suggests Billy Burrows of the Better Retirement Group. “But it is also worth asking whether you really need to take the maximum allowable.”

Scheme pension could provide a higher income than capped drawdown while allowing investors to retain control of their funds.

This is possible as the income limits for scheme pension are calculated by an actuary based on the individual pension member’s fund size and life expectancy. But these schemes can come with additional costs to cover actuarial fees.

Flexible annuities are another alternative that may offer more income. MGM Advantage, a provider, says investment-backed annuities can offer starting income typically 20 per cent higher than a level conventional annuity. This is because an individual’s health factors can be taken into account when setting income limits which is not currently done with capped drawdown.