Drawdown Pension Plan Dilemma.



Posted on: 19th April 2012

Five years on from the peak of drawdown pension plans being written many clients are reluctant to continue with these plans and are looking for Haven IFA Ltd to investigate alternatives.

Since their introduction in 1995, drawdown pension plans have been widely regarded as an alternative to the traditional lifetime annuity.

Many welcomed the option to unlock tax-free cash without taking out an annuity while others were attracted to retaining ownership of the funds and the flexibility of the policy with regards income levels and lump sum death benefits. Arguably, the use of drawdown plans peaked in 2007, which coincided with the FTSE 100 Index hitting a high of 6,730 during June 2007. Five years on and Summer 2012 will see many clients approaching their fifth anniversary and their first formal maximum income review, and many may well be in for a shock.

Downward Pressure.

So what has happened during the past five years to cause significant downward pressure on the income available from drawdown policies and what options are available to those clients looking for a simpler solution to their retirement income needs while maintaining a degree of flexibility?

Since 2007, stock market-linked investments have experienced dramatic fluctuations in their values. Shortly after the highs of June 2007, the impact of the banking crisis and the credit crunch took hold and the FTSE 100 fell to a low of 3,512 in March 2009. Although the FTSE has steadily recovered since then it still remains around 10% lower than it was in 2007.

April 2011 also saw the coalition government alter the GAD tables to reflect changes in life expectancy and, as a result, the maximum income from drawdown plans was reduced from 120% to 100% of GAD. In addition, over the past five years, 15-year gilt yields gradually fell from around 4.5% to 2.5%, thus reducing GAD rates further.

To illustrate the impact, for a male aged 65 with a pot of £100,000 in July 2007 the maximum income drawn would have been £9,250 per annum. On the same basis today the maximum income is £5,500 per annum.

For clients reliant upon their income and who have continued to draw it, the downturn in investment performance combined with changes in legislation and a drop in GAD rates have all contributed to lowering the maximum allowable income.

Most clients approaching the fifth anniversary of their drawdown plan will have to face the reality that their annual income will be significantly lower now compared to what they have relied on for the past five years.

Alternative Strategies.

Although invested funds have not had the best ride over the past five years, I still believe a diversified portfolio built around equities will offer the best long-term solution for those who require an income in retirement, but also one which can potentially rise to hedge against inflation.

Pension Plans to Look Out For.

Some of the plans being considered for our clients include Prudential’s Income Choice Annuity (ICA) and MGM’s Flexible Income Annuity (FIA). Both policies have similar benefits in that they offer a simplified investment proposition, a guaranteed income for life, potential to obtain a higher income compared to both conventional lifetime annuities and drawdown and to build in a spouse’s benefit.
Both offer minimum and maximum income bandings, which the client can choose an income between, while having the security that their income can never fall below the minimum. An added benefit is income levels can be further enhanced by taking into account the client’s (and that of the spouse’s) health and lifestyle status.

Other such strategies include Aviva’s Fixed Term Annuity (FTA) – a five-year plan which, on maturity, returns a guaranteed fund. As this is the minimum that can ever be returned, there are never any nasty surprises. However, a major difference compared to other FTAs is that there is the potential for capital growth and for the maturity value to increase if the underlying fund performs well.

On maturity, the client then has the opportunity to review their retirement options again based upon their prevailing health status, personal circumstance and market conditions at the time. This may allow them to secure a more competitive income or result in a restructuring of benefits such as inclusion or removal of a spouse’s pension due to changes in their personal life.

Clients who are in drawdown and are approaching their fifth anniversary will want to explore their options. A suitable solution that provides a higher income coupled with the potential for growth, but without the risks of drawdown? Now could well be the time to take a look at ‘third way’.