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Drawdown decisions

Daniel Cheeseman, sales manager at Selectapension, analyses the effects of this year’s rule changes on income drawdown

Income drawdown has been grabbing the headlines lately. Thousands of pensioners who entered drawdown now face the prospect of a dramatically reduced income as their plans come up for review.

On top of this, at the end of October, the FSA announced that it has contacted IFA firms that conduct income drawdown business. The regulator plans to review the quality of advice being provided and determine whether account is being taken of the rule changes introduced in April 2011, putting increased pressure on IFAs to ensure they satisfy compliance requirements.

The rule changes in April saw the abolition of the effective obligation to buy an annuity at age 75 while draw-down was restricted to 100 per cent of the equivalent annuity rate rather than 120 per cent, as it was under the former unsecured pension system.

Flexible drawdown was also introduced to allow anyone who can demonstrate that they have a guaranteed life income of £20,000 a year to take unlimited sums from their drawdown pot.

Although not without risk, there are many who have appreciated the flexibility, investment options and death benefits it provides over the years.

The question is, what is the appetite for income drawdown in the current market and have the rule changes had any impact on clients’ behaviour?

To gain some insight on these issues, we examined the report data analysed by IFAs through the Selectapension income drawdown calculators for the six months before and after April 6.

Trends before the rule change in April 2011

For the six months to April 2011, crystallised cases run through the Selectapension system reveal an average pension fund of £134,481 providing an annual income of £10,974. This is based on a 65-year-old male and using 2006 Government Actuary’s Department tables with 4 per cent gilt yield index taking the maximum 120 per cent GAD rate. This equates to £68 per £1,000 fund.

The average pension fund for uncrystallised cases run through the system during this timeframe was £97,706.

For a straight comparison of income drawdown funds, IFAs ran analysis for pension funds totalling nearly £205m with an average fund size of £233,000.

Trends after April 2011 rule change

After April 2011, there was an 18 per cent increase in the number of crystallised cases run through the Selectapension income drawdown calculators with an average fund size of £152,312 providing an annual income of £10,053.

So, while the fund size is bigger, the income is smaller than it would have been before April 2011.

Again, this is based on a 65-year-old male but uses 2011 GAD tables, 4 per cent gilt yield index and 100 per cent of GAD rate to reflect the rule change. This equates to £66 per £1,000 fund.

Analysis of uncrystallised cases after April 2011 increased by 21 percent with a slightly larger average fund size of £104,522.

The number of IFAs running comparisons of income drawdown products through the software increased by 22 per cent, with pension funds totalling nearly £145m analysed with an average fund size of £130,000. This represents a fall of £103,000.

What do these figures tell us? The most stark statistic is the huge fall in fund values for cases run after April 2011. In August 2011, the FTSE 100 fell by 9 per cent and continued market volatility has clearly taken its toll on pension savings.

This volatility combined with historically low annuity rates and rising inflation has given those approaching retirement some difficult choices.

In this environment, it is perhaps not surprising that there has been increased interest in drawdown.

By leaving their funds invested, there is a chance of clients benefiting from future investment returns and more attractive annuity rates. To what extent the rule changes are influencing this decision is hard to say.

The rule changes have made income drawdown a more flexible option than before but many of the fundamental benefits have remained the same.

Control of the underlying pension fund income, timing of annuity purchase and payment of the residual fund – minus tax – on death remain the key drivers of this market.

As the markets look set to remain volatile for some months to come, it seems likely that interest in income drawdown will remain strong as increasing numbers of people seek ways to mitigate their pension fund losses.

Whether this strategy pays off for savers in the long run remains to be seen but for many it seems the prospect of locking into a lifetime annuity right now is unappealing.

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