NEWSLETTER:SIPP/SSAS and the Case of the Disappearing Pension

Contributed by MW Pensions. [www.mwpensions.co.uk]

This newsletter is intended as technical support for Financial and other professional advisers. Members of the general public should not rely upon it.

Falling drawdown rates
There have been a number of reports in the press - both trade and the national press – about how the new drawdown limits are affecting pension scheme members.

So this month we look at some facts, and then consider the implications, both for members and the Treasury.

GAD rates
Since 6th April 2006, the level of permissible drawdown income has been determined using GAD rates, published by HMRC and based on work done by the Government Actuaries Department. Very broadly, the GAD rates reflect current annuity rates (though obviously they exclude expense loadings etc). The key elements for GAD rates are:

1. Age
2. Sex
3. 15 year gilt yield
4. Mortality assumptions

Let’s look at each of these briefly in turn

Age
The age used is the age attained, in whole years. Obviously someone’s age is someone’s age, but it is interesting that at ages 84/85 the difference in the rate per £1000 is £9 or £10 per year. Arguably there is a case, at least at higher ages, for the GAD rates to be based on quarter or half ages attained. That would benefit the member by producing higher maximum pensions.

Sex
Nothing to say here!

15 year gilt yield  
This has steadily fallen over recent years. In October 2008 it was 4.5%. In October 2011 it is 2.75%. Using the same gilt yield for all ages obviously aids simplicity, but for older ages a shorter term might be more appropriate – an 85 year old does not have a 15 year expectation of life, at least not yet. With GAD rates being extended beyond age 75 from April 2011, we think consideration should be given to using a shorter term gilt yield index for higher ages. However, with the “normal” yield curve this would produce lower maximum pensions, as shorter periods reflect lower yields. So in this case using 15 year gilt yields acts in favour of the member.

Mortality assumptions
The impact of ever-improving life expectancy led to the publication of new GAD tables that were effective from April 2011, just 5 years after the original tables were issued. If we consider a male aged 60, with a 15 year gilt yield of 2.75, the rate per £1000 falls from £52pa to £48 pa, a reduction of nearly 8% 

Enter the Government
For whatever reason (and we discuss this below), the maximum drawdown reduced from 120% of GAD to 100% of GAD, with effect from 6th April 2011. By definition, that had a major impact on those who wanted, or required, to draw the maximum possible pension.

The cumulative effect
So let’s see what the impact of the recent changes has been. We took a male aged 65, with £100,000 available for drawdown. Then we looked at the maximum drawdown he could have taken as at October each year from 2008 to 2011. The results are below:

So there is a 33% reduction in the maximum pension over 3 years. So a male aged 65 in October 2008 could have drawn £8,640 a year for 5 years i.e. until the October 2013 review. But his brother, who is exactly 3 years younger, who also has a £100,000 pension fund, can only draw a maximum of £5,800 a year (to be reviewed as at October 2014).

Why?
So why have these changes been brought in, given that their effect is so dramatic? To be fair, interest rates at their current levels (and hence gilt yields) were not envisaged by the authorities or government when the original 2006 GAD tables were prepared. But when changes were being considered to be effective from April 2011, the known impact that lower gilt yields were having on maximum pensions could have taken into account in looking at overall maximum drawdown levels

The main factor is of course the reduction in the maximum rate from 120% to 100%. This was a government decision. Why was it taken? Our view is that there was probably a huge lobbying going on from the insurance industry, notably insured pension providers, who make money from their policyholders buying annuities. Annuities have their place, particularly for smaller funds, but many more sophisticated investors, with generally larger funds, like the ability to have a SIPP, so that they can keep control of their investments.

With an annuity purchase the annual pension is fixed effectively at the 100% level. So insurers might argue that it was facing “unfair” competition from SIPPs, as SIPP members could take out 20% more. For whatever reason, the government took the decision to reduce the maximum to 100%.

The impact
The result is the same, for both the member and the government – misery. For members, their maximum pension is very significantly reduced, either at commencement or on review. Our example above shows a reduction of more than 25% in just one year and 33% in 3 years. So living standards of pensioners are falling. Also for the government, as maximum income levels are reduced, so by definition are tax receipts. If someone’s income falls by 33%, their tax payable falls significantly too.

Conclusion
Sadly the implications of these changes were not thought through. We believe that there should be a restoration to the maximum 120% level, at least up to age 75. Everyone would win by such a change – both members and the government.

Gilt Yield for Drawdown
The gilt yields to be used for drawdown calculations are:

We do not give financial advice and no comments here are intended as such. The above information is based on our understanding of the legislation governing pensions at the time of writing. Before taking any action you should consult a qualified financial and/or tax adviser. Levels, bases of and reliefs from taxation may be subject to change.

This Newsletter is intended for professional advisors only, not members of the general public

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