I have an incomedrawdown plan that is about to reach its third anniversary and have been told that the amount of income I can take from it over the next three years is significantly lower than at present. Why is that and how can I stop it happening in the future?
Your situation is likely to be repeated among many income-drawdown planholders and there are a number of reasons for this. I hope that when the plan was established, you received advice about it and were warned that this might happen.
When income drawdown was introduced, the Government Actuary's Department set out rules for calculating the minimum and maximum levels of income that could be taken from a drawdown plan.
Briefly, the GAD produced a table of rates based on the sex of the planholder, their age at the start of the drawdown period and the gross redemption level of high-coupon (15 years) UK gilts. Different tables were published based on the type of pension plan and whether the fund was made up from contributions or National Insurance rebates as a result of contracting out.
These factors determined the GAD rate used to set the maximum and minimum levels of income that you could take from your plan. The rate was applied to the value of your pension after the deduction of any tax-free cash lump sum to which you were eligible.
On the third anniversary of your drawdown plan and every three years thereafter, the GAD rate is reset.
We do not know your age, sex or the date when income withdrawals started. However, it is the case that the gilt yields referred to above were higher three years ago than they are today. As an example, gilt yields three years ago were around 5 per cent compared with 4.75 per cent now.
This may not look like a significant difference but, of course, they are rates per £100 of pension fund so a big fund will see a potentially substantial lowering of the maximum and minimum income.
A second factor to consider is the value of the fund to which these rates are applied. Where has your fund been invested over the last three years? There is a good chance that at least some of your pension fund has been invested in equities. As everyone knows, the last three years have seen something of a torrid time for investors in equities and the chances are that the value of the equities in your pension fund will have fallen.
Hopefully, some of your fund will have been invested in property and fixed-interest securities and there is a reasonable expectation that the capital value of these funds will have risen over the past three years. It follows, therefore, that the investment composition of your pension fund will have determined whether or not you have a smaller or bigger fund today than you had three years ago.
If the fund is smaller, then the lower GAD rate applied to it will have produced significantly lower maximum and minimum levels of income.
In addition, the level of income you have been taking over the past three years will have had an impact on the value of your pension fund today. The higher the level of income extracted, the greater the potential erosion of your fund value. This is particularly true if the fund has been reducing in value because of investment conditions.
There can be no guarantee that this will not happen again at the next three-year anniversary of your plan. As you can see, if gilt yields are lower and the value of your fund has fallen, the maximum and minimum income levels are also likely to be lower. This is a risk taken by all income drawdown planholders.
You could, of course, decide that you will use the present value of your pension fund to purchase a guaranteed annuity but that may or may not be appropriate for your circumstances. What you should certainly do is take advice about the investment content of your pension fund and ensure that it is managed to best effect.