Pensioners benefit as income drawdown hits 3.25%
THE 15-year gilt rate, used to calculate income for those using drawdown on their pension pot, has hit 3.25% this month, up from 3% in September.
The 3.25% rate means that for every £1,000 in a pension pot commencing or renewing drawdown in October, the account holder can drawdown a maximum of £61, compared to £59 at 3%.
So someone with a £500,000 pot could expect to drawdown £30,500 today, as opposed to £29,500 last month and considerably less in July, when the rate was 2.5%.
Together with March's increase in the income drawdown limit, which adds another 20% to the earnings above, drawdown is becoming an increasingly attractive option even over private annuities, which dominate the pensions market.
Good news, but only for some
15-year gilts are long term Government bonds and rates have generally decreased over the past few years because, post financial crisis, investors preferred these more secure investments.
Falling gilt yields pushed down the government actuary department (GAD) rate, which determines the amount of income that drawdown can generate, to an all-time low of 2% in August last year.
This year, rates are picking up again and pensioners have also benefited from an increase in the income drawdown limit.
As of the end of March, those opting for income drawdown can now choose to take 120% of the GAD rate.
To reuse our example from earlier, someone with a £500,000 pension pot can drawdown £30,500 at the current GAD rate of 3.5%, that's taking the rate at face value, or 100%.
With an extra 20%, however, they'd earn £36,600 in total.
However, pensions expert Ros Altmann has warned that not everyone will be able to benefit from the improving market conditions.
"In practice, drawdown scheme rules are so inflexible that they may not permit access to this increased income now," she said.
Not everyone in income drawdown will be able to take advantage of the higher rates: only those about to enter the scheme or whose policy is up for renewal, a process that only takes place every three to five years in most cases.
In addition, pensioners can only take the extra 20% income in the 'scheme income year' following March 2013.
That means many people will have to wait until March next year to increase their income from 100% to 120% of GAD.
Drawdown vs annuities
Standard Life's Investment director Alistair Black has said that, "2013 could be a very important year for income drawdown."
Ray Chinn, head of pensions and investment at the LV= agrees.
"[Income drawdown is] a product that advisers should be seriously looking at with their clients and an area where advisers can really justify their fees in terms of increased income," he told FTAdviser last week.
For investors, however, drawdown's renewed buoyancy forces a difficult choice between going into drawdown and the tried and tested route of purchasing an annuity.
Drawdown can offer greater flexibility than an annuity in terms of income and investment, although, as noted above, there are still strict limits on renewing rates.
Money in income drawdown also grows free of income and capital gains tax, although passing the amount on to relatives at death will make it subject to the 55% inheritance tax.
On the other hand, annuities are far more predictable: they're offering a guaranteed income for the rest of the investor's life and may even increase the amount they offer in line with inflation.
They can also offer higher returns for those with health problems.
Either way, investing a retirement fund is not a decision to be taken lightly or without help.
Turning away from expert help
Which is a shame because it seems that, as a result of changes in paying for advice, more people are making their decision without expert help than ever.
The decision to charge flat fees rather than a commission for financial advice was welcomed by many, including Nick Cann, CEO of the Institute of Financial Planning (IFP) who wrote for us on the subject, because it has made advice charging far more transparent.
Those seeking advice can be assured that the adviser is promoting the best product, not the one that pays them the most commission.
However, some have since argued that high fees may put older people, many of whom are asset rich but cash poor, from seeking advice at all.
A report from the University of Hull and Bournemouth University, released last month, found that many older people were seeking financial advice from health professionals and social workers, rather than trained advisers.