Pension Incomes & The Gilt Rate Crisis
Every client reaching pension age, or who has an impending pension drawdown review, has been facing falling pension income rates in recent years.
This has reached crisis proportions in recent months as yields on 15 year gilts, the basis of the rate at which people can draw from pensions, has fallen to all-time lows. Gilts are also known as government bonds or treasury bonds.
This fall has been driven by the enormous “flight to gilts” since the financial crisis. This flight was driven by the fall in interest rates and the perceived safety of these assets, and exacerbated by the quantitive easing programme. These have all acted together to cause what many believe to be an asset bubble in the gilt market.
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As annuity rates are driven by the prevailing yield on these gilts, the asset bubble has caused a commensurate, and dramatic, fall in the running yield of these government bonds. The net result is a much lower rate for people looking to convert their pension funds into a fixed income for life, known as the annuity.
The same problem exists for those who are in income drawdown from their pension. Not only has their pension fund had to suffer at the volatility of the prevailing market, the income that they can draw from that fund, set by the government and known as the Government Actuarial Department (GAD) rate, is also directly linked to the prevailing gilt rate. This has meant that those taking a drawdown pension are all facing lower incomes as a result of the lower GAD drawdown rate that will now apply if their 3 year review of maximum income falls at this time.
To yet further exacerbate the problem for those in drawdown, the government recently restricted the maximum that could be taken via drawdown from 120% of the prevailing GAD rate, to 100%. This has caused those facing a drawdown review to experience a double-whammy effect, causing a dramatic fall in income. This can be even worse still if the fund value has fallen since the last review.
Options for the client
Unfortunately there is no obvious solution to this phenomena as the 2 main options, annuity or drawdown, while different, are both linked to gilt rates. This lowering of gilt rates has been particularly pernicious for those who cannot afford to delay buying an annuity, and so fixing their income for life. They are left with little option than to purchase an annuity at a market low level (unlikely to be good value) or delay their retirement until the gilt, and therefore annuity rates, improve.
Nobody can know when, or if, annuity rates will improve but they are certainly now at all-time lows. For instance, the GAD rate table, published on the HMRC website, does not go any lower than last month’s market gilt rate. If the gilt rate falls any further, a new table will be required to meet these exceptional market conditions.
Some economists believe, though nobody can be sure, that without quantitive easing, gilt rates would be at least 2% higher than currently. Some also believe that the gilt market is overvalued and that yields must rise. The question is, when?
Furthermore, while most agree that rates must go up at some point, please note that gilt rates could go down further still and there is no predicting when they might rise again to historically typical values.
While few would wish to see a sudden bursting of the gilt bubble that most believe to exist, if this were to happen, it would cause gilt yields to rise and better annuity pension rates to prevail. Sadly, nobody can know with certainty what will happen in the short term.
This leaves those facing a decision on their pension incomes facing difficult decisions and requiring expert advice. A full appraisal of the clients overall assets, alternative incomes, attitude to risk, and view of gilt rate prospects should be covered by any adviser who is interested in obtaining an informed consent form their client.
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