Capped drawdown: change could see pensioners' income drop by 10%
A small change to the rules governing income drawdown for pensions could mean thousands of people’s pension income plummets in the next few months.
If you accessed your pension before April 2015 and entered into a ‘capped drawdown’ arrangement with your pension provider you could soon see your retirement income drop.
Under the rules of capped drawdown, pensioners were allowed to access their pension in order to draw an income, but they could leave their pot invested in the hope that it would continue to grow.
This has worked out very well for many pensioners as the stock market has boomed in recent years.
To level out the good news the Government imposed a limit on how much income you could take each year.
How capped drawdown works
Anyone who opted for this income drawdown arrangement has their annual allowance – how much they can withdraw as income – set by a complex calculation, taking into account their age, the value of their pension and the yield on 15-year gilts.
That latter factor, gilt yields, could have decimated pension incomes in recent years as yields have tumbled to below 1% in the wake of the Brexit vote.
However, HMRC maintained a minimum gilt yield of 2% for the purposes of income drawdown calculations. This has gone some way to protecting the income of pensioners in capped drawdown arrangements.
That is about to change.
From July, HMRC is removing the minimum yield requirement for the annual allowance calculations, which could result in pensioners seeing a sudden dip in their income.
“Many people will have seen their pots increase dramatically over the past years as stock markets have risen but because of the removal of the floor, a 65-year-old could see their pension income drop by around 10%,” Alistair Cunningham of Wingate Financial Planning told the Telegraph.
A 65-year-old with a pension worth £200,000 would have a maximum annual income of £15,900 at present. However, if the gilt yield used for the calculation fell from 2% to 1.75% the income cap would fall to £15,300. That’s a loss of £600 a year.
If yields were to fall below 1% – as they did last August – then this same pensioner’s annual income cap would plummet to £14,100 – a loss of £1,800 a year.
One way you can avoid the problem is to move your pension out of a capped drawdown arrangement and into the new system introduced in April 2015, which allows you to access all of your retirement savings and do what you like with them – this is known as flexible drawdown.
A significant drawback
Under the old capped drawdown system, a pensioner who had accessed their pension pot could still make pension contributions and benefit from tax relief up to the full annual allowance of £40,000.
If you didn’t access your pension until after April 2015 and are therefore in flexible drawdown, your annual allowance for tax relief on pension contributions is far, far lower at £4,000.
If you are still in a position to make sizeable payments into your pension and you’ve entered a capped drawdown arrangement, you’ll need to look at the sums carefully before deciding whether to switch into a flexible drawdown pension scheme.
Anyone who decides to stick with their capped drawdown scheme should check whether their pension company can bring forward their annual or tri-annual review to before July. That way you can enjoy the benefit of the minimum yield protection for a little bit longer.
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