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Capped drawdown: don't get caught in the GAD trap

Capped drawdown: don't get caught in the GAD trap

Although it has not been possible to set up any new capped drawdown arrangements since 5 April 2015, existing ones can continue. Staying in capped drawdown can be useful for members who want to go on receiving pension income without triggering the money purchase annual allowance (MPAA). Provided they do not trigger it in other ways, of course.

With the government’s recent confirmation that the MPAA reduction from £10,000 to £4,000 will be backdated to 6 April 2017, this could be even more advantageous for those still funding pensions.

Capped drawdown members can take pension income of up to 150% Government Actuary's Department (GAD), but don’t have to take any. It is also possible to take more than 150% GAD – but this automatically converts the plan to flexi-access drawdown and triggers the MPAA.

Regular reviews

GAD is based on long-term gilt yields, the member’s age and their capped drawdown fund value. A seemingly obscure change to the GAD tables came into force on 1 July 2017. As a result, some members’ incomes will reduce at their next review if gilt yields remain very low.

This is because the 2017 GAD tables cover gilt yields down to 0% and replaced tables covering gilt yields down to 2%, with the 2% rates applying if actual gilt yields were lower.

Providers have to recalculate GAD every three years for the under 75s in capped drawdown, and every year for those aged 75 and over.

Adding funds to an existing capped drawdown arrangement also triggers a review. For the under 75s, so does using funds for annuity purchase or a pension debit following divorce. The under 75s can also request early reviews.

Example

Susan had a three-year review of her capped drawdown plan in July 2017. She was 67 with a £125,000 drawdown fund. Her previous review was in July 2014 when she was 64 with a £120,000 fund. Her maximum income fell as a result of the new GAD tables.

Back in July 2014, the gilt yield for capped drawdown was 3.21%. That gave GAD of £58 per £1,000 of fund or £6,960. So in the year up to July 2017 she could withdraw up to 150% GAD – or £10,440.

The gilt yield for July 2017 was 1.56%, giving GAD of £53 per £1,000 of fund or £6,625. 150% GAD has therefore fallen to £9,937.50.

If the previous GAD tables had still been in force, Susan would have benefitted from GAD based on a 2% gilt yield. At £56 per £1,000 of fund, that would have given £7,000 equating to 150% GAD of £10,500.

Transferring funds

If a member’s income reduces, their options include converting to flexi-access drawdown – normally by asking their provider to do this. However, this will trigger the MPAA.

If a member still has any uncrystallised funds, they might be able to increment their capped drawdown plan to provide extra income – without triggering the MPAA.

However, some providers set up a new drawdown arrangement every time a member crystallises additional funds and can only offer flexi-access drawdown from 6 April 2015. Affected members could consider transferring their capped drawdown and uncrystallised funds to another provider that can increment existing capped drawdown.

For those who have funds with different providers, transferring just the drawdown or uncrystallised funds might also solve the problem. All forms of drawdown to drawdown transfers are authorised provided the funds are received into an empty arrangement.

Adding new funds to capped drawdown triggers a lifetime allowance test. As with flexi-access drawdown, there’s a second lifetime allowance test if the member is still in drawdown at age 75 – although this doesn’t apply to any funds already in drawdown by 5 April 2006.

The death benefits are the same as for flexi-access drawdown. Under 75, any remaining funds within the member’s available LTA provide tax free death benefits. From age 75, the death benefits are taxed at the beneficiary's marginal income tax rate.

Bernadette Lewis is financial planning manager at Scottish Widows

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