Flexible drawdown

Flexing drawdown for better client outcomes

This article has been written by the technical department at Standard Life

Flexibility to vary income to adapt to changing needs is perhaps the key appeal of income drawdown. So the drawdown changes announced in March's Budget create a catalyst for advice to help drawdown clients achieve better outcomes in retirement.


Advice is the key to good client outcomes

Standard Life's research shows that, particularly for wealthier clients, income needs are unlikely to match the conventional pension income shapes produced by annuities or defined benefit schemes.

SMILE!
•For many, we've identified a 'retirement income smile' pattern. This is driven by higher demand for income early in retirement when clients are still active. Income needs drop off with age, then pick up again as personal assistance and long term care needs develop.

•Others simply want a relatively modest, sustainable income – but with scope to turn it up if their circumstances change.

•Some wealthy clients' main need is to draw as much income as early as possible to gift to loved ones, via trusts or pension plans as well as directly, as part of a wealth transfer strategy.

Income drawdown is well suited to meet all these diverse client needs and aims. And the higher the income limit available, the more room there is to manoeuvre. Which is why the Budget announcement was so welcome.

But it's not about always taking the maximum allowed, it's about having the flexibility to take more income when it's needed and cut it back again when it isn't.

This is where advice is key. Drawdown isn't a 'self-service' option. It's complicated. There has never been a better time for advisers to demonstrate their true worth by helping drawdown clients do the right thing to exploit this flexibility to attain their financial goals.



Where did it all go wrong?

Drawdown users, and their advisers, have had a rough ride in the last few years. Markets have been difficult. But much of the pain has been imposed by the drawdown regime itself:

•The linking of drawdown rates to gilt yields means that plunging yields fuelled by QE have had a disproportionate impact on income limits.

•And the 20% limit cut, and new GAD tables, in 2011 simply compounded the problems.

A typical example illustrates this:

•A 60 year old man starting drawdown with a £100,000 pot in August 2007 (when gilt yields were 5.25%) would have had an income limit of £8,280 a year.

•At his 5-yearly review in August 2012, even if he'd maintained his £100,000 pot, this client's new income limit would only have been £5,300 (56% lower than the old limit)! This is partly owing to the 20% headline limit cut – but primarily because, by then, the gilt yield had dropped to 2%.

It's a case of the tail wagging the dog. Logically, with the same pot having to last him 5 years less, this gent's allowable income should have gone up!



Light at the end of the tunnel – an advice opportunity

Thankfully core elements are coalescing to create light at the end of the tunnel.

•Most importantly, gilt yields appear to have at last bottomed out (IG: but remember, this may not be the case and they could fall further).

•Markets remain volatile, but they're well up on the lows of 2009 that saw the FTSE 100 drop to almost 3,500. And the increasing availability of sophisticated, risk-based investment solutions makes it easier to reduce the volatility that can be so damaging in a decumulation environment.

•These factors, combined with the move back to 120%, should get income limits back to more realistic levels from the start of drawdown users' next income year after 25 March 2013.

Here is an example:

Edith started pension drawdown on 1 August 2012. She was 60, her drawdown pot was worth £150k and the GAD drawdown yield was 2.0% - giving an income limit of £6,450.

If no action is taken, this will simply increase by 20% to £7,740 from 1 August 2013.

But what if Edith triggers an earlier review by paying more money into her drawdown pot on 30 March? Changes since August could really boost her income limit:

•Unisex rates: Edith now benefits from 'unisex' (male) drawdown rates, following the implementation of the EU Gender Directive into UK law in December 2012.

•Rising yields: The GAD drawdown yield has gone up from 2.0% to 2.75% since August 2012.

•Rising markets: The FTSE has grown by about 25% over the same period. Suppose Edith's drawdown fund has done the same. So, even after taking her maximum £6,450 income, it's now worth about £180k.

•Getting older: And Edith has had a birthday, so is now 61.

Edith's new 100% income limit is £9,360 – allowing her to take an extra £2,910 from her drawdown pot before her new income year starts on 1 August.

This will increase by 20% to £11,232 on 1 August - over 45% more than if no action was taken (and over 74% higher than her August 2012 limit).


And the Government's kick-start of an early review to get GAD drawdown rates themselves back to reality mean there's more good news in the pipeline.


For example, improving market conditions mean advisers can potentially help boost clients' income limits sooner than the start of their next income year. This can also turbocharge the effect of the 20% hike when it comes. An early income review can be triggered simply by phasing more funds into an existing drawdown pot. Or by requesting an ad hoc limits review from the start of the new drawdown year.



This sort of flexibility supports holistic advice strategies that help put the client's needs first. Which is what drawdown is all about. But good professional advice is the key that can unlock it – creating the fundamental building blocks for the successful use of income drawdown as part of an efficient, flexible, but sustainable wealth decumulation strategy.

If you are a client of Green Financial - or not - and would like an income drawdown review, please contact me

State Pensions and the missing £144,625.81

Pension Insight magazine (http://www.pensions-insight.co.uk ) editor Bob Campion recently wrote that the gradual reduction in maximum state pension benefits could end up costing some people £144,625.81.
He calculated this is the amount you’d need to buy an annuity to replace the lost £6,326.84 a year if the maximum state pension reduced from £13,606.84 to £7,280

The £13,606.84 is the theoretical maximum for someone with full basic state pension (BSP, currently £102.15pw in 2011/12 available to those with more than 30 years NI contributions) and maximum second state pensions (SERPS and S2P). This contrasts with the maximum £7,280 payable if we move to the proposed £140 per week flat rate system. It would affect most higher earners and those who do not qualify for any kind of pension credits or means tested pension top ups. At present almost 1 in 2 pensioners are eligible for top ups of some kind but for those who do not qualify for state assistance over and above the basic state pension the changes to state pension rules looks likely to mean a significant reduction in available benefits over the coming decades, with less effect on those retiring sooner, especially in the next 10 years.

As a point of interest if the new rules all come in when proposed (but it looks likely they will be brought forwards) it will be into the 2080’s before everyone is on the same rate. Until then there will be a mixture of different regimes and people will have multiple pensions (private and state) with different rules and retirement ages applying depending on age and pension structure.

This makes it nigh on impossible to accurately calculate one’s own state pension benefits until the point you reach them. Indeed even the DWP are not really sure what income a pensioner will get until they reach state pension age (65 and rising). As an IFA it makes it financially impractical to charge a client to work this out. The time and cost involved outweigh the benefit!

Contracting out (called SERPS up until April 2002 and S2P afterwards) will soon no longer be available from money purchase schemes, which includes personal pensions and SIPPs – see also http://greenfinancial.blogspot.com/2011/12/contracting-out-serps-s2p-all-that.html

It used to be the case, that as an IFA, I could estimate whether it was ‘worth’ contracting out or not. There were a multitude of individual factors but the biggest was often if aged under or over 45. So the ending of contracting out from money purchase schemes is a welcome simplification but as indicated above the change to the new regime will bring complification [ED: not a real word but should be] well into the 2080s. Again, on the plus side, the new rules should benefit lower earners.

But what is the detriment to higher earners?

The loss of the income as stated at outset in this article is one but there is another. The impact on attaining qualification for the new ‘flexible drawdown’
- download Green Financial guide here:  http://www.iangreen.com/downloads/Flexible.pdf
or view on facebook here:
http://www.facebook.com/media/set/?set=a.279726955386751.88831.136170059742442&type=1&l=b96248bd07

This requires a lifetime pension income provision of at least £20,000. So having state benefits of £13,000+ goes much further towards this than £7,280! If you had the £13,606 to buy a comparable annuity to top up to £20,000 would mean you’d need a personal pension of about £93,000 to buy the annuity. At the lower state pension income you’d need more like £200,000 to top up.

To repeat a fact I tweeted last year, to purchase an annuity (so income for life) on the same terms as the state pension a 65 year old male would need a private pension fund of £310,343.19

So in summary, pension and state pension simplification is of course welcomed by all, especially me as I will be far better placed to assist clients in calculating what there state pension entitlement might be. But the journey to a simple state pension regime is far from defined and will be a long journey whatever direction it takes.
Under current proposals I’ll be aged 109 when all pensioners are on a flat rate pension income!

For those retiring in the next ten years, there is not so much to worry about as the status quo all but applies, with changes to retirement age (upwards, see link to calculator below to work out yours) being the main factor coming slowly in.

But for those retiring 10 years out, especially those who aspire to or consider they will have taxable income at the higher rate of tax it is well worth making sure your pension – and most importantly forecast pension income - is reviewed to ensure it is on track to meet your aims.

If you are a pension or retirement income client of Green Financial or would be interested in becoming one, please do contact us. We’d love to help if possible.

Further Reading and Resources

28 page Green Financial Retirement Planning Guide - http://www.iangreen.com/downloads/Retirement.pdf

Government Money Advice Service - http://www.moneyadviceservice.org.uk/yourmoney/pensions_and_retirement/default.aspx

State Pension Age Calculator -
http://pensions-service.direct.gov.uk/en/state-pension-age-calculator/home.asp

Getting a State Pension Forecast - http://www.direct.gov.uk/en/Pensionsandretirementplanning/StatePension/StatePensionforecast/DG_10014008

Green PEAs – The Green financial Pension Evaluation and Analysis Service for personal pensions -
http://www.iangreen.com/pensionperformance.php