The disaster of income drawdown

On the face of it, 'income drawdown' looks like a good alternative to buying an annuity. But start drawing down today and you could find yourself with much less cash than you would like, says Merryn Somerset Webb.

It is an unfortunate truth that almost everything the government tries to make better it ends up making worse. And so it is with pension legislation.

Take income drawdown. This, on the face of it, looks like a fabulous alternative to buying an annuity with your pension money particularly at a time when annuity rates are as shockingly low as they are now (thank you, quantitative easing).

It works like this: rather than handing all your money over to an insurance company on your retirement, you keep your pension invested one way or another and simply draw an income from it. This has the benefit of keeping your money in your own name and of allowing you to pass it on to your heirs (subject to a 55% tax charge). All good.

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There is, however, also a problem with income drawdown the government gets to decide how much income you can take every year. The number is decided by the Government Actuary's Department (GAD) and linked to the yield on the 15-year gilt at the time you start taking an income. It is then, as The Mail on Sunday puts it, "set in stone" for three years, at which point it is reviewed based on the new 15-year gilt rate (the eventual rate decided on is known as the GAD rate).

The problem? Firstly, that last April the government cut the amount you can take from 120% of the GAD to 100%, and secondly that the GAD is now at a record low.

That means that anyone either starting drawdown today or getting their drawdown reviewed today is going to find themselves with rather less cash than they would like. In 2007, for example, a 55-year-old man with a £100,000 pension pot would have been allowed to draw down £7,200 a year. Today, at 60, he would be allowed a mere £4,600. His income has fallen by 36%.

There isn't much today's pensioners can do about these issues in the immediate term, but it might be worth them writing to their MPs to support a new campaign fronted by Ros Altmann, director-general of Saga, and Andy Bell, chief executive of pensions provider AJ Bell. They are both livid (with good reason) that pensioners are suffering in this way as a direct result of quantitative easing which has pushed down gilt rates, and hence the GAD rate.

But they also can't see why income drawdown has to be related to gilt returns in the first place. Why, says Bell given that pensioners can spend capital as well as income, something that means market returns have "no direct relevance to drawdown investors" can't pensioners simply take out a percentage of their fund every year? Why indeed.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.