The growing popularity of Income Drawdown

by Bob Cook

While it would not be right to say the Financial Services Authority (FSA) don’t like Income Drawdown, they certainly have some concerns about it. Their particular concerns are around customers fully understanding the product, particularly if they plan to use Income Drawdown to provide income throughout their retirement.

While regular fund reviews aim to keep the fund alive for as long as possible, poor investment returns coupled with particularly small pension funds could mean that the customers fund completely runs out. This would mean no income in retirement.  For this reason many income drawdown providers will not take customers with funds after tax free cash that are worth less than £100,000. Some won’t accept funds after tax free cash that are less than £37,500. An annuity of course will provide a guaranteed annuity for life.

However there can be no doubt that the recent European Gender directive and the Government’s decision to reinstate the higher drawdown income limit (120% GAD)[1] previously available via income drawdown, make it a more attractive proposition for customers who are looking for the highest possible income from outset and are prepared to take the risk that either their fund could run out, or in the long term they may have been better off buying an annuity. The 120% rate, available from March 2013, now gives customers higher income at outset than conventional annuities.

Based on quotes produced on 20th March 2013 [2], a customer aged 65 who has a fund of £100,000 (after tax free cash) could expect to receive £5,585 per annum. However the maximum initial income available from an income drawdown contract is £5,800 per annum.

While I have explained that the risk with income drawdown is that the fund value will fall and the income could reduce, it should not be overlooked that, as the fund remains under your control, a successful investment strategy could actually grow or maintain the fund value and therefore potentially increase the income.

With income drawdown the customer also has the ability to alter the amount of income they take, including turning it off altogether. They can take anything from 0% – 120% GAD. As many people age their need for income reduces. A customer may therefore opt to take the maximum possible income while they are still young and mobile, with the plan to reduce the income and maintain the fund when they are older.

It is this flexibility of the drawdown contract coupled with the fact that any unused fund that is in the contract when you die passes to your spouse, family or estate (even with a potential 55% tax charge in some cases) that makes income drawdown a very attractive product for many customers. Even those with relatively small funds.

The regulator is right to be concerned about the product, but I think they will nevertheless see increasing sales of Drawdown. The challenge for financial services companies is to make sure they are providing the customer with sufficient information to fully understand the product.

 

 

[1] GAD stands for Government Actuary’s Department. GAD produces tables of annuity rates, on behalf of HM Revenue & Customs, which are used to calculate the maximum drawdown pension that can be taken from a drawdown pension fund (otherwise known as income drawdown or income withdrawal). These products were formerly known as either unsecured pension funds or alternatively secured pension funds.

[2] Quotes produced on 20th March 2013 using the Assureweb quotation portal