Cash Q&A: Pension payouts fall as new legislation begins to take effect

Q. I have an income drawdown pension plan that is approaching its first review. I have been told by my pension provider that the maximum income that I can take will be virtually halved. This has obviously come as a shock. Please can you tell my why this is happening? What can I do about it?

GH Edinburgh

A. You are in the same boat as many others who hold income drawdown plans that are approaching their first review, although I realise that offers little comfort. There are four main factors that could have contributed to your reduced level of income.

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The first is that since you took out your plan the government has introduced legislation that has reduced the maximum income that you can draw from fund.

This applies to all plans effected after 6 April 2011 but only came into force at the first review for plans taken out before this date. This has the effect of reducing the maximum income drawdown level available for most drawdown plans by roughly 17 per cent.

The maximum level of income available at review depends on the level of pension fund within your drawdown plan. Poor investment performance over recent years may have reduced your investment funds.

If the level of income you are taking is greater than investment growth, net of charges, then your fund will be eroding.

A relatively straightforward calculation that you can use to assess the sustainability of your income is to calculate your gross income as a percentage of your fund value and then compare this with the past performance of the investments held within your pension.

A final factor that contributed to the reduction in your maximum allowable income is the fall in the GAD (Government Actuary Department) rates that are used to calculate your income at each review date. GAD rates are determined by your sex, age, gilt yields and mortality rates. UK gilt yields have fallen to historic lows, which is in part due to the government buying their own bonds through the quantitative easing programme.

In addition, mortality rates are declining as people are on average living longer and longer each year.

All of the above factors will have had an influence on the revised income you can draw from the plan. There are options available to you, however.

Instead of continuing to draw an income from your drawdown plan you could use your drawdown fund to purchase an annuity, to provide a guaranteed income for life. However, the income you would be offered is largely determined by annuity rates, which have also fallen in recent years.

An annuity is a one-off purchase and cannot be undone once the commitment has been made. Annuity rates could be higher in the future but could also be lower.

If there are factors that could reduce your lifespan (such as smoking or illness) the initial level of annual income offered by an annuity could be increased by up to 30 per cent (through buying an enhanced annuity).

Another option is flexible drawdown, which would allow you to draw down up to your entire fund in one lump sum if you can meet the minimum income requirement of £20,000 a year (from state pension, final salary pension and any annuity income you may receive). Assuming you have already taken the full tax-free cash from your plan this lump sum would be subject to income tax at your highest marginal rate. This was recently introduced by government legislation but you will have to check to see if you qualify and if your current provider offers this facility.

• Mark Thornton-Smith is a financial planner at Cornerstone Asset Management LLP.

If you have a question for Cash Clinic, write to Jeff Salway, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or email: [email protected]

The above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and Cornerstone Asset Management LLP accept no liability on the basis of this article.