Interest rates remain low, as do gilt yields. They will go up, but there are various downward pressures like Solvency II, the removal of gender as a pricing point and - most particularly - the growth of underwritten annuities (impaired life and enhanced) that take the substandard lives from the annuity pool, leaving the good lives and thus forcing rates down. Indeed, some of this is self-perpetuating, as the poor prognosis on rates leads to more people choosing income drawdown with the same effect.
This is likely to become more pronounced as the market for underwriting individual annuities increases, and also as people continue to choose income drawdown because it looks attractive.
Falling gilt yields and the effect that these have had on drawdown are well documented, and were addressed to some extent in the 2012 Autumn Statement with the increase in the capped drawdown limit from 100% to 120% of an equivalent annuity.
This change took place with effect from 26 March 2013. As a follow up to this it was announced in the Budget that the Government Actuary’s Department (GAD) would be commissioned to review the pensions drawdown table and the underlying assumptions used to provide GAD rates to make sure they continue to reflect the annuity market.
Now, I fully welcome some further consideration of retirement options, but with the annuity market not looking good, why should the drawdown regime reflect this downward trend?
Pensions do tend to get a bad press and one of the triggers is when the income that can be withdrawn is reduced/restricted. This is not helped by the fact that an unintended consequence of quantitative easing - falling gilt yields - means many people in income drawdown have a heightened opinion that pensions are overly complicated and restrictive.
When income drawdown started in 1995 it was very much seen as an annuity deferral mechanism to be used by individuals for a period of time until the annuity rates available to them improved. This is now not the case and more people are considering income drawdown as an end in itself, as opposed to a means to an end (annuity purchase).
Indeed, over the last few weeks an increasing number of financial advisers I have spoken with have confirmed a growing demand for income drawdown from individuals with smaller pension pots (or pots smaller than traditionalists would view as large enough for income drawdown).
So, returning to the statement in the Budget, is it now time to dismantle the connection between GAD tables and annuities altogether, and to recognise that the two options which used to be so closely linked are now separate solutions?
In the run-up to the restoration of the 20% uplift to the GAD rates a number of new ideas for income drawdown were put forward, including a couple suggesting a drawdown rate that was linked solely to the retiree’s age.
The aim was not to allow a massive discrepancy between the income levels under annuities and drawdown, but to take away the link to something that, realistically, was not so relevant. If people have made the decision not to buy an annuity, it seems illogical that the income available from the alternative is governed by the option that they have decided not to take!
The advice process will remain the same. An annuity is an insurance policy (insurance against living too long) and income drawdown is an investment product. By definition the two are used for different things and are at two ends of a spectrum that also includes temporary annuities, variable annuities and investment-linked annuities in between. Drawdown needs an understanding of the client’s attitude to risk and capacity for loss.
Currently the drawdown market is dominated by personal pensions and SIPPs, but the perceived poor value of annuities is also spreading to the corporate defined contribution market, and there have been calls for DC schemes to make more use of drawdown instead of annuities to increase retirement benefits.
The next few years will see the mass of the baby boom generation reaching retirement with the forecast of billions of pounds coming into the retirement market. This is a real opportunity for manufacturers to look at designing income options that are attractive to consumers. To kick start such a process a bit of a nudge from the legislators and the regulator would be a great start.
Mike Morrison,
Head of Platform Marketing,
AJ Bell