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26 March 2013 last updated
Capped drawdown rules allow 20% more income for people retiring

Changes to capped drawdown rules from today will allow people retiring to benefit from a new maximum income from their pension fund 20% higher making drawdown more attractive than a pension annuity for highest income.

Chancellor George Osborne decided in the Autumn Statement last year to increase the maximum draw from pension drawdown from 100% to 120% of the Government's Actuary's Department (GAD) limit.

The GAD limit is based on the 15-year gilt yields and these have decreased significantly from 3.98% in June 2011 to 2.36% today restricting people in capped drawdown to a lower income than a lifetime pension annuity.

For those approaching their review dates it also threatened to reduce the maximum income they could take by 20% assuming the fund value remained the same, even though they were five years older and could receive more income.

Capped drawdown rules allow 20% more income
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Capped drawdown impacted by lower gilt yields

Originally the government reduced the maximum income from capped drawdown to 100% to protect people from taking too much from their pension fund. However, as gilt yields reduced from 3.98% to an all time low of 2.02% in August 2012 it also reduced the maximum income allowable from drawdown.

GAD rates use the 15-year gilt yields to determine limits for every £1,000 of income and yields have been at all time lows last year with some improvements to date as shown below:

  Gilt yields used to calculate drawdown (%)
Aug Sep Oct Nov Dec Jan Feb Mar
2.00 2.25 2.00 2.00 2.25 2.50 2.75 2.50

For example, a male aged 65 with a fund of £100,000 in April 2011 could take a maximum income draw at 120% of £7,680 pa compared to a lifetime annuity at the time of on a single life, level of £6,813 pa.

In March this year with gilt yields at 2.50% and 100% GAD limits for someone aged 65 the income draw had reduced to £5,600 pa, a reduction of £2,080 pa or 27.0% on the original figure. In contrast after significant falls in annuity rates, a lifetime annuity provides an income of £5,485 pa. The capped drawdown changes will allow people to take £6,720 pa which is 22.5% greater than the lifetime annuity and approximately the level that the government wanted when they changed the limit to 100% back in April 2011.

Pension funds could be depleted at maximum limits

The new maximum limits of 120% GAD (see income drawdown for how this is calculated) increases the risk of pensioners depleting their fund over time. If the investment growth in the fund does not keep up with the withdrawals the fund value will decrease over time. To reduce the possibility of depletion capped drawdown is reviewed every three years and new maximum limits based on the revised fund value.

Pensioners must ensure they do not require to take the maximum income from drawdown to avoid the fund reducing in size and therefore capped drawdown is only suitable for larger funds of £200,000 or more or if there are other pension benefits and investments to provide additional income.

Capped drawdown can be useful if an individual has a serious medical condition rather than purchasing an
impaired annuity which would offer an enhanced income levels. In the event of their death annuities would end on the annuitant's life unless a spouse's benefit was added, however, with drawdown the whole fund would be available to their spouse to draw an income or buy annuities.

News related stories:
Income drawdown rates increase for women with gender neutral pricing
Pension drawdown now 20% more income for pensioners
Related internet links:
BBC - Income drawdown warning to pensioners
Telegraph - Income drawdown 20% more income from pension
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