People who have come to rely on a retirement income from drawdown are facing major cuts in the amount of money available. Not only is this a significant issue for clients, but the Financial Services Authority (FSA) is concerned about the inadequate and unsuitable advice on drawdown it has uncovered.
Drawdown is far from straightforward and is riddled with risks. However, I have a proposition that would make drawdown more straightforward and help the advice process.
The maximum amount of income that can be taken is linked to the annuity rate for a single person and is reviewed at intervals; every three years up to age 75 and annually thereafter.
However, annuity rates have fallen significantly, contributing to falls of as much as 50% when income is recalculated.
There is a lot of pressure on the government to address the problem, with possible options varying from quick fixes, such as reinstating the old 120% factor that used to apply to the Government Actuary’s Department’s annuity rates or using higher corporate bond yields, to a full revamp of the system.
Age-linked annuity rates
My preferred option to address the issue is incredibly simple: just change the annuity rate that is used for the drawdown calculation to the member’s age: a 60-year-old could withdraw income of £60 per £1,000 of fund, a 75-year-old could withdraw £75 per £1,000 and so on.
There is no underlying theoretical basis for this approach, but it works. It broadly follows the pattern of annuity rates that increase with age.
It does not require any complex actuarial tables and introduces certainty into the picture. This last factor would help retirement planning enormously because it means that those in drawdown would know in advance where they stand.
Any proposal to change a system will have its opponents, and I have no doubt this approach can be tweaked, if necessary, to deal with any valid criticisms.
An alternative is to tweak the current system by introducing a no-reduction factor into the equation: whenever the maximum income drawdown is recalculated, the old maximum income remains in place if the new one is lower.
This is more consistent with the concept of mirroring an annuity rate and it would also introduce more certainty of income into the process.
The key issue with this type of approach is that it could result in the fund running out of money at some stage.
Hyman Wolanski is managing director of Sippchoice.