Who is income drawdown most suitable for?
Tom McPhail: Anyone who can tolerate investment risk – capital and income fluctuations – in retirement and who is prepared to accept a suitable level of equity exposure in pursuitof investment returns.
Ideally, they should be willing to pay for adviceor be sufficiently financially literate to take on responsibility for running the arrangement themselves.
Amanda Davidson: Young retirees, those prepared to take some risk, who want to retain control over their capital, who hate the idea of dying the month after they retire and leaving large sums to an annuity provider, those who have bigger pots of money over 200,000 and those who have other assets.
Stuart Bayliss: When used to provide pension income,the individual must be willing to take investment risk over the longer termand have an income need which, on average, represents less than 5 per cent of the fund. Any use of higher or maximum levels of income should be planned and relatively short term, for example, using any excess investment gains.
Many others will pass through income drawdown, often not taking any income, as part of their phased retirement planning.
McPhail: It is an issue but,for increasing numbers of people, it will not be a major issue. This is because an increasing proportionof investors who reach retirement age are also likely to reach age 75. This means that many people who go into drawdown will still end up annuitising in the fullness of time. They will simply use drawdown as an annuity-deferral mechanism.
Longevity will obviouslybe much more of an issueif the investor has good reason to believe that they will not make it to 75.
Davidson: How long are you expected to live? Here, the tensions would be between how big an income you could get personally compared with the desire to leavethe pension pot to a nextof kin if you anticipatedying before 75.
If you have other assets, there may be compromises in what you leave to whom and how, as the pension fund can be put in trust to help with inheritance tax planningif this is an issue.
Bayliss: Average life expectancy is important in helping to validate whether drawdown is suitable fora client but not necessarilyin deciding between income drawdown and an annuity.
An individual’s life expectancy may be important here but eligibility for an impaired life annuity does not always makethe annuity the appropriate choice, particularly at younger ages and mild impairment.
Should advisers be concerned about possible futurechanges to the regulationof income drawdown, similar to the changes to altern-atively secured pensionswe saw last year?
McPhail: Probably not.The Asp debacle was an ideological tantrum fromthe Treasury concerning the inheritability of pension funds. They seem pretty relaxed with the death benefits up to age 75, onthe basis that the funds will ultimately be used for income and will not be passed down the generations – something which gets them peculiarly agitated.
Davidson: Yes. We are often making pension choicesfor clients where their timeframes are very long to take benefits. When talking to someone in their 30s or 40s, the only certainty I can give them is that there willbe changes by the timethey reach 75.
However, you have to get on with the regime you have or you are just like a rabbitin the headlights, paralysed by indecision and mostlikely to end up in a stew.
Bayliss: No. The changes to Asp were not a U-turn as is often described. Almost all the errors in communication were those of the industry. The Government had always made its position clearthat pensions were notto be a source of capital. Drawdown regulations remain consistent since 1995 with very little change other than improvements in income limits, etc.
Is 75 too low an age to effectively force people to annuit-ise? And does this age limit, combined with the punitive tax charges on alternatively secured pensions remove some of the attractionfor income drawdown?
McPhail: Yes the age limit is too low – it should probably be pushed up to 80 or 85. However, for now, I think there is still a very healthy market for drawdown among investors who are happy to take the investment control in their 60s and 70s andto exchange that for the security and certainty ofan annuity in their 70s. However, it does make unsecured income planning for someone in their 70s more particular as the adviser has to bear in mind the reduced timescale toa crystallisation of value.
Bayliss: There is no forced annuitisation at the age of 75. Seventy-five is too young to allow people to opt outof the annuity mortality cross-subsidy pool by wayof a 10-year guarantee.
The change in income limits from USP to Asp and the potential capital taxes does restrict income drawdown but at least the requirement to convert ator on the 75th birthday has been taken away.
McPhail: Oh yes, and I think this will continue to expand over the next few years.Investors will increasingly look for flexibility in the early years of retirement or even to take their tax-free cash before retirement and to use thisas a transition phase ontheir way to a securedincome later in life.
Davidson: I think the true answer to this question is only because I am getting older and my clients with me. Nil income is, of course, useful for clients who havea range of assets and needto manage them andthe tax issues fromvarious wrappers.
Bayliss: Yes, there is no doubt that, as indicated in my first answer, many will pass through USP as part of their retirement process, using USP to take their tax-free cash and nil income on either all or parts of their fund while they are still in work. This would be particularly asso-ciated with people seekingto move from full-time to three or four days a week, etc.