28th January 2014 at 10:00am
Did you know that some people will be able to enjoy a 33% increase in their pension income this year?
The combined effect of two changes could mean a potential windfall for those choosing to use the income drawdown option on their pension. This blog explains the background to what’s happened.
Did you know that some people will be able to enjoy a 33% increase in their pension income this year?What exactly is income drawdown?
Drawdown is an alternative to an annuity in providing pension income. It gives you flexibility and the potential to benefit from investment growth, but you may need to live with some stock market risk.
If you choose drawdown, you have a pot of money which is used to generate your income. To help ensure that your pot of money will always provide you with income, the government has set rules on how much you can take each year. It’s a bit like a bank account with a limit to withdrawals from a cash machine, which are capped at a certain amount each day. We calculate a maximum limit when you first take money out of your pension, and re-calculate it regularly after that.
How does the government calculate your income?
The amount of drawdown income you can take depends on your age and the value of your pension fund. But it also depends on the interest rate from government bonds (which are also referred to as gilt yields).
The government has a table which is used in these calculations. It takes account of your age and the gilt yield, and tells us how much income you can take for each £1,000 you have in your fund. This is what the government expects you to receive if you had chosen an annuity.
How do people take income drawdown?
As soon as you decide to take your lump sum from your pension, we have to calculate a maximum income that you can take from what’s left. Did you know that a third of our customers choose to take no income at the start, just their lump sum? These customers could still be working, or using their lump sum to provide some income.
But unlike an annuity, you have more flexibility with drawdown, as you can take an income between £0 and the maximum each year. So, let’s say you had a maximum income limit of £20,000 but you only needed £15,000. You could take £15,000 this year and £20,000 in year 2. Or you could take £15,000 as a regular income and take £5,000 as an ad-hoc payment during the year.
At any time you can increase, decrease, stop or start your income as long as you stay within the limit that has been set. You can take a regular income or take lump sums when you need, or both.
The maximum annual income for a 65 year old in January 2013 for a £200,000 pension pot was £11,000. The same figure in January 2014 is £14,640!But this maximum income changes – why?
The government doesn’t want you to run out of money, so it sets a maximum amount you can take out using drawdown. It also requires you to re-check your maximum income every 3 years (and yearly if you are aged 75 or older). If investment performance has been poor or you have taken out a lot of money, then you will have less income to take out in the future.
The government rules are intended to mean that you don’t run out of money. But of course the great thing is that, if investment performance has been good, or you haven’t taken out too much money, your maximum withdrawals could increase. This would give you even more flexibility.
How flexible is income drawdown?
You don’t have to wait for 3 years until your next review. You can choose to review your income every year. So if your fund value does increase, then you can benefit from this quickly. And reward yourself with a little extra. It’s up to you.
What’s changed in 2014?
The boost in 2014 comes from two things. Firstly, the gilt yield that we use in the income calculation has increased by 1% to 3.25%, comparing January 2014 to January 2013.
Secondly, it takes account of the impact of a change which happened in 2013. Last year, the maximum withdrawal limit was increased from 100% to 120%. Taking these two changes together, this means that your maximum income could be 33% more if you chose drawdown now as opposed to 12 months ago.
But if you are already in drawdown on the lower 100% income maximum, then don’t despair. Your maximum income will be increasing by 20% anyway (without you doing anything – this is just a response to a previous change in law). And you could perhaps get the full 33% if you asked for an annual review.
And what could this mean in your pocket?
The maximum annual income for a 65 year old in January 2013 for a £200,000 pension pot was £11,000.
The same figure in January 2014 is £14,640!
So it’s great news for some drawdown users – along with control and flexibility to access your income, there is now a welcome boost to the maximum income you can take too.
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The value of an investment can fall as well as rise and is not guaranteed. You may get back less than you put in. Past Performance is not a guide to future performance. Taking maximum income every year will increase your chance of reduced income in the future.