More may mean less with latest drawdown reforms

John Moret assesses the latest income drawdown reforms

Victory for pensioners hit by tighter drawdown cap" was just one of the headlines in the press following the announcement that the Treasury plan to reinstate the 120% (of GAD rates) maximum income limit for income drawdown.

While welcoming this latest U-turn in government policy on income options at retirement I worry this will turn out at best to be a Pyrrhic victory.

Despite its relatively short lifespan there are few areas in the world of pensions which have been subject to more legislative change. By my reckoning the latest announcement is the fifth attempt by successive governments to find a more acceptable method of determining how much income can be taken each year.

From outset legislators have misguidedly viewed drawdown as an extension to annuity options rather than a real alternative. Why else would you base income limits on a proxy to annuity rates?

For most of drawdown's lifespan the legislative and regulatory focus has been on risk - but with much greater emphasis on the risk of depleting funds prematurely through excessive income drawings rather than on investment risk and in particular the risks posed by adverse timing of investment returns.

Complexity

Successive layers of legislation have also contrived to make the operation of drawdown far more complicated than is needed. The 2011 reforms provided an ideal opportunity to sweep this away but that opportunity was not taken despite industry consultation. Instead we continue to have reams of regulation.

In the face of the disastrous consequences of the new regime for many users of drawdown the industry has come up with a range of possible options. However some of the more radical and in my view enlightened proposals involve breaking the link with annuity rates completely and designing a much simpler and imaginative regime where annual income limits are simply determined by the length of time to a certain age - say 90.

I believe it would be a mistake for the industry to simply readopt the 120% limit. Instead we need to pressurise the Treasury for a genuine alternative to annuities which is simple to understand, durable and provides stability.

Aside from the link to GAD rates the major issue with the current capped drawdown regime is the artificiality of determining maximum income levels at fixed intervals. This inevitably leads to big spikes in maximum income levels which make longer term planning a lottery.

New approach

I propose that three simple criteria should be used to design a new drawdown regime:
i. A minimum threshold level of ‘qualifying' capital (not income and to include certain non-pension assets) to allow drawdown to be utilised combined with automatic conversion to an annuity if in future capital falls below this threshold level;
ii. Maximum income levels to be recalculated annually based on a defined multiple of the reciprocal of the number of years to age 90 and size of fund;
iii. If and while total ‘qualifying' capital exceeds a certain higher threshold level an enhanced multiple can be used for determining maximum annual income.

The appropriate capital threshold levels and longevity factors would need to be agreed. My initial proposal would be a minimum capital level of £150,000, a second tier capital threshold of £400,000 and multiples based on 1.5 (1.75 for ages up to 65) and 2 (2.5 for ages up to 65) times the reciprocal of the number of years to age 90. The relevant multiples compared with 120% of GAD rates at various rates of interest are illustrated in the table (below).

One can debate the appropriate multiples and threshold limits but I believe this approach would be much simpler. There would simply be two age-related tables which do not change with interest rates or time (other than an occasional review of the base age of 90) - providing stability while retaining flexibility.

I believe it is vital the industry keeps up the pressure for reform -and does not allow the Treasury to believe it can sweep the issue under the ‘fixed it' carpet following the Budget statement.

John Moret is principal of MoretoSIPPs