Latest News › A Falling GAD Rate

A perfect storm has pushed the income on government bonds to its lowest ever levels. A chaotic economic environment has pushed investors into ‘safe havens’, creating significant demand for government bonds, pushing prices higher and income (or ‘yield’) lower. The Government itself has created artificial demand for government bonds through its quantitative easing programme. Finally, monetary policy in the aftermath of the 2008 credit crisis has seen interest rates fall to historic lows.

The repercussions of this fall in yield on government bonds are not only felt by those directly invested in government bonds. Pension income is linked to government bonds yields in a number of ways. First, it determines the level of annuity income received. Annuity rates are currently half their level of 10 years ago.

It also determines GAD rates, which govern how much a retiree can withdraw from their pension pot when they are in ‘capped’ drawdown. The Government puts a cap on how much retirees can withdraw from their pension pot unless they have £20,000 of guaranteed pension income from another source (such as a final salary pension scheme).  Rates vary from individual to individual, but in general a 65 year old man retiring in 2006, when gilts yields were over 5% could have taken £75 per £1000 of funds, whereas the same figure now, with gilt yields at approximately 2.75% is £58.

These lower GAD rates affect existing retirees as well as those retiring now. Drawdown policies are subject to periodic review and in 2011 the Government shorted this from five to three years (kicking in at the next review). The Government has also reduced the amount that can be withdrawn from a pension pot from 120% of the GAD rate to 100%. It is those who are approaching this periodic review – those that retired in 2006 and 2007 - that are particularly vulnerable.

The problem has been compounded by the fact that many investors in drawdown have their pension pot at least partly invested in equities. As the income allowance is based on the size of the pension pot as well, the turbulence in the equity market has also reduced the amount some investors can withdraw.

It is an ugly picture. However, before getting too gloomy, it should be said that GAD and annuity rates are updated frequently. Although the consensus among economists is that interest rates are likely to remain low for some time, the ‘safe haven’ trade that has seen investors move large sums into government bonds is waning. There are increasing concerns about the high prices of government bonds, which suggests that the cycle could start to reverse.

Equally, this in no way spells the end of drawdown. The flexibility of a drawdown policy makes real sense for some people and there are inheritance tax advantages as well. The answer for many retirees may be a blended approach of drawdown and annuity or the use of flexible drawdown policies. Retirees also need a coherent plan to withdrawal levels while in drawdown, based on their cashflow needs. It also highlights the need for retirees to achieve the best rates in both drawdown and from their annuities.

Posted on 04 Nov 2011