Advisers should be aware income drawdown may not be the most sustainable way of providing income for their clients, and should consider a scheme pension instead.
Rowanmoor Pensions points out advisers need to warn clients taking out the maximum amounts as defined by the Government Actuary’s Department (GAD) could reduce their income as the value of the fund falls.
It warns once the income levels exceed the return on the underlying investments then the fund value will fall and the longer the retiree lives the chances are greater that the income will have to reduce.
David Seaton, director of Rowanmoor pensions says for example in an Alternatively Secured Pension (ASP), drawdown after the age of 75, the maximum level of drawdown is 6.93%, which with a £500,000 fund is an income of £34,650, but to maintain this level of income the fund growth has to be at least 6.93%, which is quite a high target to maintain.
And Rowanmoor points out if advisers recommending income drawdown, either before or after the age of 75, fail to ensure their clients have a sustainable level of income in retirement they may be held liable.
Just last week the Financial Services Authority (FSA) publicly censured a company, GD Tancred Financial Services, for failing to explain the risks associated with income drawdown on funds of less than £100,000.
In addition when a person changes from Unsecured Pension (USP) to ASP at the age of 75, the maximum income they can take drops, in some cases by up to 40%, to ensure individuals do not drain their pension funds and end up relying on the State.
As a result Rownamoor is offering a Sustainable Income Report, developed by actuaries on an individual client basis, to provide advisers with a tool demonstrating how taking the maximum income drawdown would affect future income.
Rowanmoor says if a client has a fund of £800,000, takes £200,000 as a lump sum and then draw the maximum USP income from the age of 51, they could start with an income of £35,711.
With an assumed 6% rate of fund growth it suggest income will remain around the £34,000 - £36,000 until the age of 76 when it will drop to £19,238 and then to £18,242 by the age of 81.
Meanwhile Rowanmoor claims a more sustainable level of income can be obtained through the use of a scheme pension, as this avoids the risk of funds dropping at the age of 75, and it suggests an individual with the same pension fund could start with an income of £20,888 which will have increased to £50,578 by the time they reach 81.
This is a result of annual income reviews where the level of income is calculated to allow for future pension increases at the rate of long term inflation assumed to be 3%.
In addition when using a scheme pension in a Small Self Administered Scheme (Ssas) Seaton points out there is no Inheritance Tax (IHT) charge when the residual funds are shared out between the remaining members.
Seaton adds: “This research shows taking a scheme pension avoids the risk of income plummeting at age 75 and if ASP is withdrawn by the government, scheme pensions will be the only alternative to buying an annuity after the age of 75.”
And he says Rowanmoor is making it a mandatory requirement for its own advisory service for anyone about to enter drawdown, with the report initially costing £200 then £50 for every update, which he says is not a significant amount from the fund of someone seriously considering drawdown.
Seaton argues all too many advisers have no understanding of the science behind their recommendations and says the report provides evidence for the FSA to show the adviser has pointed out the risks of income drawdown to the client.
He adds: “Some people are suggesting income drawdown is the next mis-selling scandal. Most people want to take too much income from their pension scheme in the early days, causing problems in the future. It is essential advisers ensure their clients have a sustainable income for a full retirement.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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