Andrew Roberts discusses the impact of recent changes to income drawdown
Major changes are upon us that could transform the world of income drawdown advice. There is good news and bad news, as ever, but has the government got the balance right? I think so, but behavioural changes might throw up some unwanted consequences.
Readers are no doubt familiar with income drawdown and that, while the 2006 pension rules did not require compulsory annuity purchase by age 75, such purchase was encouraged by the rules governing drawdown beyond age 75.
Specifically, drawdown limits beyond that age were set lower than annuity rates and pension funds paid out on death to family were taxed at 70% or more, depending on circumstances.
The new government is harmonising drawdown rules so that there is no major distinction between drawing before or after age 75. For someone approaching retirement with a money purchase pot, there are three mainstream options: annuity purchase, traditional income drawdown and a new form of uncapped drawdown. The new rules focus on the latter two, though lump sums paid on death under value protected annuities will be taxed at 55% rather than 35%.
Traditional income drawdown will be available for life, but the maximum drawdown rate will be similar to single life annuity rates, as determined by the government's actuary department. The so-called "GAD" tables listing the rates have been recalculated to take account of improved mortality and have been extended to age 85.
While the rule changes improve the drawdown rates available from age 75, the maximum drawdown available beforehand is about 20% less than that available under the current rules.
Impact on advice
There is clearly an impact on retirement advice and individual consumers may favour a secure annuity income over the less secure, but potentially more rewarding, income drawdown route given that initial pension income will be similar under both contracts. Therefore, you could argue that the rules favour annuitisation at retirement.
At our recent seminars attended by high net-worth SIPP and SSAS members, roughly two-thirds of the audience supported the government in introducing one form of income drawdown for life, even at the expense of reducing income drawdown flexibility before age 75.
The government has also used the rule changes to introduce an effective need to use your fund on your death to provide an income for your dependant, in preference to making lump sum payments to beneficiaries. It has done this by setting the tax payable on lump sum distributions at 55% - i.e. higher than inheritance tax and higher than income tax. At our seminars, the majority supported this move as part of the package of improving the position beyond age 75.
I mentioned a new uncapped form of drawdown, flexible drawdown. This will be available to those who can demonstrate that they have sufficient secure income (deemed to be £20,000 this year) not to need state help in the future. Under flexible drawdown, funds can be withdrawn from the pension pot as and when requested, and paid out less income tax.
There is a strong argument that those who do not have pension resources to secure £20,000 to £25,000 of income should not be using income drawdown in the first place and should look to buy an annuity - unless they have personal wealth to sustain their cost of living.
And those with the right level of secure pension income could qualify for flexible drawdown, even if they intend to draw an income for life from their funds (rather than aggressively draw down funds so that the pension pot dries up within a few years - a tactic that about one-fifth of our audience were interested in).
We may therefore see that the new rules squeeze out the traditional form of income drawdown in favour of annuity purchase for those with low pension resources (of less than £250,000) and flexible drawdown for those with more.
I am not certain that this is what the government intended and hope that any behavioural changes do not prompt ministers to more pension rule tweaking.
Andrew Roberts is a partner at Barnett Waddingham
Slow progress in improving diversity
Share purchase deal with assets of £28m
Came into effect in January
Three examples of compensation rule issues
Buying in baskets