Martian language on pension changes

On 26th March 2013 the Government are going to allow the GAD rate to be increased to 120%.

If you understood what that last sentence meant then well done. On the other hand if it sounded like it was ‘Martian’, here I hope is an explanation.

When a pension plan owner reaches the point where they want to take their benefits (usually after tax free cash), they might typically buy an annuity with the balance of the funds.

This will then provide them with a guaranteed gross income for life.

Leaving aside the fact that annuity rates for a whole host of reasons are at a relatively low (if not historically low) level, an alternative (for some people) is not to buy an annuity but to use income drawdown (more precisely known as unsecured pension) to receive their pension income.

How much income they can receive for this approach is determined by rates set by the Government Actuary’s Department or GAD.

The GAD rate is based primarily on Gilt yields as well as the age of the pension plan owner. It is a rate that is equivalent to a single life annuity for the same person.

Since income drawdown was introduced in 1995, the GAD rate was always 20% higher an the single life annuity rate but last year the Government decided to reduce it back to 100% of the single life annuity rate.

Those who were taking this maximum rate saw their income fall sharply particularly as gilt yields were also very depressed.

There was a good deal of complaint about this change and it has resulted in a return to the 120% level, so perhaps some good news for some.

Pleas note that there are a number of important risks to consider what ever method you use to convert your pension plan into income. Both annuity purchase and ‘income drawdown’ have advantages and disadvantages to consider.

Seek professional advice before you take any action.

Photo credit: Flickr/Dirty Bunny