October 2012 News and Views Special AJ Bell proposes blueprint for new income drawdown rules What is a record, dad? my twelve-year-old son asked when I told him I was in danger of sounding like a broken one regarding some work stuff I am trying to change. What would you prefer, as an alternative? was his next question, which sort of stopped me in my tracks. It then struck me that, whilst I have thrown several ideas into the ring as to how the income drawdown rules could be improved, I haven t actually committed to an alternative regime. Out of the mouths of babes I thought, and off I trotted to my study to follow my eldest son s advice. Before putting pen to paper, I reminded myself that the thrust of my concerns could be distilled into something fairly simple. The combination of the drawdown rules introduced from April 2011 and the continued reliance on 15 year gilt yields as a means for calculating maximum drawdown income have caused an imbalance between the need, which I accept, for risk mitigation and the fl exibility that clients value. The introduction of fl exible drawdown confi rms unequivocally that the Government s main concern in drawdown policy is to minimise any risk of individuals needing to fall back on state benefi ts because of excessive fund depletion. The principle of fl exible drawdown is that if you can convince the Government that you won t fall back on state benefi ts, then you can take as much of your pension fund as taxable income as you choose. Excessive fund depletion is an understandable concern, but I believe the risk has been overstated. I do not know whether this is a result of reliance on the research carried out by the Pensions Policy Institute into the risk of fund depletion. If it was, then it shouldn t have been, as this research was rendered fundamentally fl awed when the PPI ignored the protection offered by triennial and annual income reviews. So, in developing my blueprint, I set myself certain constraints and decided that the alternative rules must: offer protection against individuals needing to fall back on state benefi ts be at least tax revenue neutral be simple not rely on any investment-return related factor, as this will have no relevance to drawdown investors reward those with the lowest probability of falling back on to state benefi ts, with the greatest fl exibility
Blueprint My blueprint is set out in the tables below: Basic drawdown rate for funds <200,000 Maximum income p.a. as % of fund 55-59 5 60-69 6 70-79 7 80-89 8 90+ 9 Enhanced drawdown rate for funds (applied only to the excess) >200,000 Maximum income p.a. as % of fund 55+ 10 It is based on the simple premise that there is an increased risk of individuals falling back on state benefi ts if they hold pensions valued below a certain fi gure. I have used 200,000 but this could be set at a different level. When savers hold pensions above this value, then the risk decreases and greater fl exibility in drawdown income can be afforded to them. If their pensions fall below this value, then the additional fl exibility is removed and they fall back on the basic rate. There are obviously wrinkles in terms of members with multiple pension pots, those in phased drawdown and the valuation of different types of pension, but the above acts as a simple starting point. For what it is worth, I would keep the rules simple and only look at drawdown funds when considering the limit (i.e. uncrystallised benefi ts are ignored) and I would make it provider-specifi c (i.e. someone with multiple pension pots could be disadvantaged). Politically, this would lead to enhanced tax revenues and increased spending as my conclusion is that pension savers want the fl exibility to choose to draw more taxable income than they can at the moment, and it normally only makes sense to draw funds if they are to be spent. In my view the present system of capped drawdown does not allow clients enough income certainty and fl exibility in the early years of drawdown but, almost perversely, due to our old friend mortality drag, it does allow too much income to be taken in later life. The use of a standard GAD annuity table is also no longer relevant in an age when postcode, size of fund, lifestyle and medical history are all refl ected in an individual s annuity options. We need to create clear water between the alternatives of annuity purchase and income drawdown they really are oranges and apples, but linking the two gives a false sense of similarity. A comparison of my new proposals with current annuity rates and capped drawdown maximum income levels, both present and from fi ve years ago, is set out below. It demonstrates the increased certainty and income stability offered by my proposals: November 2007 max capped drawdown p.a. Current maximum capped drawdown p.a. Current annuity income p.a. Maximum under AJ Bell s proposal p.a. 55 7,200 4,100 4,813 5,000 60 7,800 4,600 5,199 6,000 65 8,760 5,300 6,049 6,000 70 10,200 6,200 6,757 7,000 74 11,760 7,300 8,220 7,000 (The comparison uses capped drawdown factors for a man commencing drawdown in both November 2007 and November 2012 with a fund of 100,000 and annuity rates without guarantees or widow s pension taken from the Money Advice Service website for a man in the M32 postcode area without any lifestyle or medical enhancements.) Andy Bell s News & Views Special 2
I am delighted that we really seem to be getting some momentum in this campaign. Front page headlines in the Mail on Sunday s personal fi nance supplement last weekend, loads of wider press coverage and hundreds of letters written to MPs. My jungle drums tell me that politicians are listening. Comparisons I have prepared some fi gures to help illustrate and compare my blueprint with the present capped drawdown rules. I hope that you will fi nd the following tables of interest. 1. Comparison of present drawdown factors ( based on 2% p.a. gilt yield ) and my proposed combination of basic and enhanced drawdown. Current maximum income p.a. Fund of 100,000 Fund of 500,000 Maximum under AJ Bell s proposal p.a. Current maximum income p.a. Maximum under AJ Bell s proposal p.a. 55 4,100 5,000 20,500 40,000 60 4,600 6,000 23,000 42,000 65 5,300 6,000 26,500 42,000 70 6,200 7,000 31,000 44,000 75 7,700 7,000 38,500 44,000 80 10,100 8,000 50,500 46,000 85 14,000 8,000 70,000 46,000 90 14,000 9,000 70,000 48,000 You can see from this comparison that my proposal allows more fl exibility at younger ages, but restricts those from around age 75 and onwards. It also provides a signifi cant enhancement for those with more substantial pension pots, who are much less likely to fall back on the state for support in later life. My blueprint acknowledges that we are all living longer, and that the risk of mortality drag having a major effect is becoming an important consideration the longer an annuity purchase is deferred. I am all for more client fl exibility in the early years of retirement, but only if the client s pension pot can still support a meaningful income in later life. Interestingly, the Offi ce for National Statistics indicates that a male currently aged 65 has a fi fty/fi fty chance of reaching age 89, and a one-in-four chance of reaching age 95. If the main long term concern is the risk of an individual falling back on the state, then the present capped drawdown system does not solve this. The greatest risk of drawdown funds being insuffi cient to support an individual is likely to occur when they are in their 80s or 90s. My proposal attempts to reduce the risk of the remaining fund being unable to support enough drawdown income to keep someone off additional state benefits. I have set out below two tables showing the projected funds and maximum drawdown incomes for a 55-year-old man. One looks at a starting fund of 200,000 and the other at a starting fund of 500,000. It is clearly very unlikely that a client would use a drawdown fund for 30 or 40 years without achieving any positive investment return, let alone continue to draw maximum income for that entire period but, if the main political concern is excessive depletion of funds, we do need to consider extreme situations. The tables compare the present capped drawdown rules with my proposals. I have made the following assumptions: Future investment growth of nil, 4% p.a. and 8% p.a. net of all fees and charges. No change to the present GAD factors and underlying gilt yield of 2% p.a. Maximum income is drawn annually in advance for each drawdown year. Andy Bell s News & Views Special 3
2. Projection table for initial fund of 200,000 Assumed growth rate Nil 4% 8% Fund at age 55 200,000 200,000 200,000 200,000 200,000 200,000 Maximum income 8,200 10,000 8,200 10,000 8,200 10,000 Fund at age 60 159,964 153,000 196,022 187,796 238,272 226,714 Maximum income 7,718 8,500 8,727 9,625 9,820 11,688 Fund at age 65 124,108 111,381 186,918 168,481 276,881 241,110 Maximum income 6,670 7,109 9,659 10,340 13,778 15,917 Fund at age 70 92,159 79,673 171,344 149,082 310,508 249,148 Maximum income 5,714 5,577 10,623 10,436 19,251 19,121 Fund at age 75 64,515 54,130 147,651 124,863 326,616 248,362 Maximum income 4,968 3,789 11,369 9,367 22,656 18,941 Fund at age 80 41,237 37,658 110,407 105,687 306,750 246,120 Maximum income 4,165 3,013 11,151 8,455 30,982 20,612 Fund at age 85 22,329 24,819 72,734 84,746 244,053 233,963 Maximum income 3,126 1,986 10,183 6,780 34,167 19,396 Fund at age 90 10,505 16,358 41,629 67,956 168,692 223,415 Maximum income 1,471 1,472 5,828 6,116 23,617 20,342 Fund at age 95 4,942 10,208 23,826 51,595 116,601 204,051 Maximum income 692 919 3,336 4,644 16,234 18,365 At even the very pessimistic nil growth rate my proposal retains more residual funds than the existing from age 83 and onwards. This means that it gives greater protection against individuals falling back on the state (which will tend to occur towards the end of drawdown, rather than in the earlier years - if it happens at all) just when it is needed. Remember that over half of the clients who enter drawdown are still likely to be alive at age 83. At the 4% growth rate the switch over takes place from age 82, continuing the improved protection, and it is at age 86 where the switch over occurs at the 8% growth rate (when, of course, there is no need to worry about falling back on the state on either ). Andy Bell s News & Views Special 4
3. Projection table for initial fund of 500,000 Assumed growth rate Nil 4% 8% Fund at age 55 500,000 500,000 500,000 500,000 500,000 500,000 Maximum income 20,500 40,000 20,500 40,000 20,500 40,000 Fund at age 60 399,912 324,000 490,052 397,313 595,678 483,561 Maximum income 19,294 28,000 21,819 33,257 24,551 38,961 Fund at age 65 310,276 216,080 467,290 316,215 692,200 460,201 Maximum income 16,675 15,120 24,147 24,895 34,444 38,457 Fund at age 70 230,402 152,390 428,328 257,396 776,269 437,498 Maximum income 14,285 10,667 26,556 19,740 48,129 37,750 Fund at age 75 161,291 103,535 369,127 208,745 816,535 407,855 Maximum income 12,419 7,247 28,423 14,875 62,873 34,786 Fund at age 80 103,095 72,038 276,017 176,399 766,871 384,499 Maximum income 10,413 5,762 27,878 14,112 77,454 34,450 Fund at age 85 55,824 47,489 174,845 141,449 610,130 354,024 Maximum income 7,815 3,799 24,478 11,316 85,418 31,402 Fund at age 90 26,262 31,299 100,072 113,422 421,729 328,361 Maximum income 3,677 2,817 14,010 10,208 59,042 30,836 Fund at age 95 12,354 20,149 55,073 86,114 291,504 295,105 Maximum income 1,730 1,813 7,710 7,750 40,811 27,511 At the nil growth rate my proposal improves the protection from age 88. Before then it refl ects the additional income that could be drawn down while the fund was worth more than 200,000. Even so, my proposal does not compare unfavourably with the present system, and does more to protect funds from being unduly depleted in old age. At the 4% growth rate the switch over takes place at age 89 and for the 8% growth rate it takes place at age 95. However, in practice these clients will retain suffi cient funds and drawdown incomes to keep them off state support. There are a number of other compelling arguments to support my proposals and allay the political fear that those taking income drawdown are potentially going to fall back on the state for support. We can start with the obvious point that drawdown investors are individuals who have made some retirement provision (that others may have not). You will know better than me, but I suspect that most individuals who have made retirement provision through pensions will also have other assets to support them in old age. There is a far greater risk of those who have built up personal wealth, but not made any pension provision, spending or giving away that wealth and falling back on the state in old age. In addition, too much safety is attributed to and assumed of those purchasing annuities. Annuities are valuable and are the right answer for many, but they are neither a cure-all, nor a completely safe option. Unfortunately, purchasing a level annuity (by far the most common option) does not protect against infl ation, and purchasing an annuity without a survivor s pension will leave the survivor with no pension income on the individual s demise. At least a drawdown fund always offers residual funds on death to provide for a survivor, as well as the opportunity to protect against infl ation by the appropriate choice of investments. I appreciate that there are some issues with the proposals which will cause a few furrowed brows, but they are the sort of issues that can be ironed out through consultation. Multiple pots, pensions from defi ned benefi t schemes, annuities already purchased and state benefi ts in payment immediately spring to mind. My view is that we need simplicity for enhanced drawdown, rather than complicated rules where each pension scheme needs to take account of other schemes. Complexity introduces cost, and that will only serve to erode the value of drawdown pots. If the proposals encourage sensible advised consolidation of multiple pots into lower cost options, this is likely to be to the benefi t of the drawdown client in the longer term. Andy Bell s News & Views Special 5
So, broken record, CD or digital fi le, I would be happy to debate and defend the above proposals in discussion with the Government. My blueprint is simple, fair, tax generative and a vote-winner. What more could the Government want? I would be interested in any feedback or comments you may have regarding my proposals. You can use the following link views@sippcentre.co.uk to make them. This document must not be copied or reproduced, in part or whole, without permission. Whilst efforts have been made to ensure the accuracy, neither the author nor his employer accept any responsibility or liability whatsoever in relation to the contents of this document. AJ Bell includes AJ Bell Holdings Limited and its wholly owned subsidiaries AJ Bell Management Limited, AJ Bell Limited and AJ Bell Securities Limited. AJ Bell Management Limited is authorised and regulated by the Financial Services Authority and is the scheme administrator of all AJ Bell s Self Invested Personal Pensions (SIPPs). AJ Bell Securities Limited is a member of the London Stock Exchange and is authorised and regulated by the Financial Services Authority. It is the plan manager for all of AJ Bell s Individual Savings Accounts (ISAs) and provides AJ Bell s Dealing Accounts. Sippdeal, Sippdealxtra and Sippcentre are platforms provided by AJ Bell Management Limited. AJ Bell Platinum SIPP is provided by AJ Bell Management Limited. AJ Bell Platinum SSAS is provided by AJ Bell Limited. The companies listed in the adjacent table are all registered in England and Wales at Trafford House, Chester Road, Manchester M32 0RS. Company Company Number VAT Number AJ Bell Holdings Limited 4503206 833 5478 13 AJ Bell Management Limited 3948391 759 3531 03 AJ Bell Limited 3091664 639 0316 44 AJ Bell Securities Limited 2723420 918 4226 21 www.sippcentre.co.uk Follow Andy Bell @Snooper66