Falling gilt yields need not trigger a lower pension income for the over 55s approaching retirement if they understand how to manipulate income drawdown rules.
The latest 15 year gilt yield has tumbled to a record low of 2.25% that typically means less income from anyone relying on an annuity or income drawdown.
The two are tied to gilt yields as annuities are typically anchored to gilts while income drawdown is calculated on the rate of return from the bonds and income drawdown rate set by government actuaries.
However, there is third variable that can be leveraged to increase pension returns.
Pension fund values are related to stock market values, and as these fluctuate, they can be harnessed to the advantage of the over 55s.
The tactics involve some brinkmanship, but with a steady strategy and good financial advice, it is possible to earn more from your pension, says investment fund provider Skandia.
Phasing income drawdown
The trick is to hold back some funds from income drawdown, while waiting for markets to improve or gilt yields to rise.
Phasing the flow of pension funds in to drawdown can realistically result in a significantly higher retirement income, argues the company.
The key is looking at the factors that determine the income generated from a pension:
• 15 year gilt yields
• Pension fund size
• Age and related factors like the drawdown percentage set by the government
All have been in decline over recent years – and the decline has the biggest impact on over 55s looking at retirement income from annuities or income drawdown.
These variables also impact anyone in income drawdown if their current maximum income is above the new 100% drawdown percentage ruling and they are approaching a statutory review.
Higher pension income
Achieving a potential higher pension income drawdown involves keeping some of the fund back – and this can be as little as a few hundred pounds.
Steady nerves are needed to wait for stock markets or gilt yields to move upwards to shift the cash reserve in to drawdown – which could be months or just a few days in today’s fast-moving markets.
The trick comes when new money is moved in to drawdown. Maximum income is recalculated based on the total cash in drawdown, provided this is allowed by the pension provider -so check this out in advance.
This could help raise income levels significantly for the remainder of the review period before the maximum income calculation is worked out again.
“When a person reaches retirement, all too often they take their maximum tax-free cash lump sum, which means the entire fund goes into drawdown,” said Skandia pension expert Adrian Walker.
“They may or may not then take an income with the remaining fund. People need to be aware of the advantages keeping a small lump sum in their pension can have when they come to drawing an income from their pension.
“Holding a small amount back, and drip feeding it, possibly on a regular basis, into drawdown could increase a persons chances of raising their overall income level if stock markets or gilt yields improve. Importantly, the entire pension can benefit from any improvement in maximum income calculations if the pension arrangement is structured in this way.
“This can give hope to those who cannot wait for gilt yields to improve before they start to take an income from their pension. Not all pension contracts offer this flexibility, so people need to check with their provider what options they have, and seek professional advice from their financial adviser.”
As an example, Skandia looks at keeping £1,000 from a £100,000 pension fund.
The figures assume taking a 25% tax-free lump sum and shifting the rest of the fund to capped drawdown.
How phasing works
In the first scenario, all the remaining pension cash is transferred in to drawdown on day 1.
In the second. £1,000 is retained and moved in to drawdown at the end of October, the end of November or the end of December 2011. No income was taken in the intervening period and the initial drawdown fund growth mirrored the FTSE 100 index.
If the £1,000 was put in to drawdown later, £250 would be paid as an additional tax free cash sum, and the maximum available income rises.
At the end of October, the increase in overall income is £350 a year, but if it was paid in at the end of November, income rises by £483 a year.
Based on last week’s changes in gilt yields, if the £1,000 was paid in to drawdown in February, maximum annual income would increase by £169 to £3,994, compared to the start of October, even though gilt yields dropped to 2.25%.
This is assuming growth in the underlying fund since October based on a FTSE 100 level as at close of markets on January 13 of 5637.
Take care when contemplating this type of retirement income manipulation. Keeping cash back and phasing drawdown can reduce pension income if gilt yields and markets fall rather than rise.
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