Workers who have sailed into retirement with a capped drawdown pension income may find that they will get less money from July 1.
Capped drawdown was abolished when pension freedoms were introduced in April 2015, but thousands of pensioners still rely on the income the old process provides.
But the ‘capped’ part of paying a pension has led to some problems.
In capped drawdown, retirement savers leave their fund invested and draw a flexible income – but the income is limited by the cap aimed at stopping someone from exhausting their pension cash too soon.
What is the GAD rate?
The cap is calculated by applying what’s called the ‘GAD rate’ to a formula that also takes in gilt yields. The GAD rate is effectively a value for every £1,000 invested that a retiree can take from their fund.
GAD is short for Government Actuary’s Department, which sets the rate.
The rate is reviewed every three years until the retiree is aged 75, then annually.
Gilt yields – the rates paid by government bonds – have shrunk in recent years and are below 2%.
The lower the gilt yield, the lower the income that can come from capped drawdown.
For example, while a 60-year-old investor might have had a capped drawdown income of £15,900 a year from a £200,000 pension fund when gilt yields were at 3% and the GAD rate was 53/1000, from July 1, the same investor will see their payslip shrink to £12,000.
Money purchase allowance pitfall
The income from capped drawdown is different for every retiree, as the figure is worked out on personal data, such as age and fund size.
Jessica List, pension technical manager at Suffolk Life, said: “If an investor still has funds that they haven’t put into drawdown, they may be able to put more funds into capped drawdown, which could boost their income limit.”
But she points out switching to flexible access to increase their pension income may trigger the money purchase annual allowance – which the government is likely to cut from £10,000 to £4,000 in the Summer Finance Bill.
List said: “If there’s a chance of needing to save into a pension again in the future, investors should seriously consider whether the MPAA gives them enough scope to do so before deciding to switch to flexi-access drawdown and take income.”