In GAD we trust?

Spending is harder than saving. When you are saving you have a retirement date to aim at and you know how much you are saving every month. There is only one unknown: what your rate of return will be. Figuring out how much you will have saved up when you retire in 30 years time is not an exact science. 

But when you get around to spending your savings [aka drawing a pension] the uncertainty is even worse. There are now two unknowns - the rate of return, and how long you will need the money for. Put crudely: you know when you will become a pensioner, but you don't know when you will cease to be one. And that's why spending is tougher than saving.

It's enough to make most savers run straight into the arms of an insurance company - swopping their £100000 of  pensions savings for a guaranteed pension [an annuity] that will pay them around £150/week for the rest of their lives. Actually the average UK  pension pot is nearer£30000, but £100 000 makes the numbers easier.

The annuity route is known in the jargon as a 'secured pension'. The alternative is an 'unsecured pension' where you can leave it invested - in a SIPP for example.

So here's the problem: if you reach retirement and have decided not to buy an annuity [yet], how much of  your £100000 can you pay yourself each year as your unsecured pension? Remember it has to last a lifetime.

Well the government actuary's department has come up with a set of guidelines - known as the GAD tables. They are roughly equivalent to the rate of payment from an annuity. Just plug in your personal details [age, sex] and the current interest rate [last month's long-term gilt rate].

For Albert [male, gilt rate 4%] the GAD rate is 6% at 60, 7% at 66, 8% at 70 and 9% at 73. The bad news for his wife Beth is that she has to wait an extra three years to reach the same levels, eg women don't hit the 7% mark until they are 69.

So at the GAD rate Albert would take £6000 a year from his pension fund. Suppose he wants more? Well he can take more. Up to 20% more. [Don't ask why  - it is just what the government rules say you can do].

So Albert has a choice of taking anything between zero and £7200 from his pension fund - no matter how well or badly it is doing. He can take this income for 5 years without having it reassessed. But at age 65 - after £36000 has been taken from his pension fund and some poor stock market returns - you can see that Albert's pension pot may well have shrunk considerably. The GAD tables guarantee neither consistency not security in pension drawdown.

What's Albert to do?

The short answer is Albert should think about taking  out the absolute maximum he can - the full £7200 - and then save half of it [say in an ISA]. Because spending the full £7200 is not 'safe', where safety means having a guaranteed fixed income until you die.

Determining what is the safe withdrawal rate has spawned a whole industry in itself - but many people believe it is around 4% - giving Albert a fixed £4000 for life but still not guaranteeing it.

The other route to go is to take a fixed percentage every year - say 5% - of the value of your fund.  Albert would get £5000 this year but couldn't be certain what he would get next year. It might be more or less than £5000 depending on how his investments had done in the meantime.

In GAD we trust? Only as a means of working out how to retrieve the  maximum amount of money from the pension tax regime. As guidelines to a sustainable fixed income in retirement they are seriously flawed. Remember:  a 70- year old could take out £8000 a year. Five years later, and after a big market drop, there would not be much left of his original £100000 pension pot.

FAQ

I don't see the point of this - why even consider settling for a still uncertain £4000 a year from a SIPP when I could get a guaranteed £6000 from an annuity.

Because the SIPP money is still partly in your control [by withdrawing the maximum allowed you can get your hands on a lot of it]. And if you die a year later, your pension pot is part of your estate [taxed at 35%]. With an annuity all your money is gone. Also if you have a SIPP, you can buy an annuity later. But once  you have got an annuity there is no changing your mind.

How come the GAD guidelines let you take out 7%; and many advisors don't recommend going  above 4-5%.

The GAD guidelines treat your money the way an insurance company would - making it last for your expected lifetime [say 20 years at 65]. And then letting you take a bit more.  Mainstream financial advisors would pencil in the need to sustain 25, 30 or even 35 years of retirement income. And that hammers the pension you can take out of your pot. [Adding eight years to your retirement calculations, from 25 to 33, could cut your pension by 25%].

So would using the GAD guidelines make my pension pot get smaller?

Probably - but don't forget that is what they are designed to do. The guidelines allow you to receive a portion of your capital back every year. All the 'income' you receive will not just be interest or dividends.