Income Drawdown maximum calculations remain stuck in neutral and poised for reverse as EU Solvency II pressures look set to push annuity rates lower

8th December 2013

George Osborne’s Autumn Statement was a disappointment for those hoping for a reappraisal of the way retirees’ income drawdown limits are calculated. Income drawdown maximums are currently based on 120% of your annuity rate as calculated by the Government’s Actuary Department (GAD). They remain hard-wired to 15-year gilt yield prices which themselves are based on Government debt levels and thus pricing. So for example the Government’s initiative of Quantitative Easing which helped dig the UK economy out of its latest hole, also had a negative effect on annuity prices because it forced a devaluation of government debt (there is just too much of it around!).

So gilt prices, despite recent upwards trends, are still operating at historically low levels and are facing the prospect of fresh downward pressure as EU Solvency II rules - coming into effect from 1st January next year – demand that pension funds hold more low performing government bonds in order to satisfy tougher capital risk management requirements.

As a result, pensioners in Income Drawdown will continue to see their incomes fall even with the reversing of the poor 2011 HM Treasury decision to reduce the GAD limit from 120% to 100%. This change was announced in Mr Osborne’s March 2013 budget speech as follows: “As annuity rates have fallen, and with the prognosis not looking particularly good, drawdown has been seen as a real alternative, providing a similar level of income but with much more flexibility and investment risk substituted for the certainty but inflexibility of an annuity.”

In this same budget speech he announced a review of GAD calculations to ensure they continue to reflect the annuity market. But we found out this week in his Autumn Statement that this eight-month review has resulted in no change to GAD calculations, despite real and increasingly vocal concern that they present overly pessimistic view of what funds can afford in terms of a retirement income.

So what might have happened to GAD calculations? There was some conjecture over the summer that GAD rates should be set based on a far more ‘real world’ mixture of gilts and investment-grade corporate bond performances.

GAD tables are not anywhere near reflective enough of what the pensioner can really afford at a given point in time. Income drawdown maximums should be based on a more dynamic assessment based on age, health profile, size of the total fund and individual fund performance profiles. By so doing it will be possible for all those in income drawdown to take a retirement income that is much more closely aligned with performance of the funds they are invested in. In short drawdown maximums ought to be based on an accurate assessment of the funds’ ability to continue to provide the target income in retirement. 120% of the current GAD figure is too rigid and frankly too negative an assessment of what’s possible.