PMI: Drawdown needs minimum income floor to avoid depleted pots

The regime in place was essentially a grudging concession to those who objected to annuitisation on largely religious grounds, and was not intended to accommodate those for whom drawdown might otherwise have represented an intelligent alternative to the permanent commitment of a lifetime annuity. 

That year saw the introduction of two new and distinct options. Both sought to mitigate the Achilles' heel of drawdown: the absence of any guarantee that the member’s fund would not be exhausted before death.

Capped drawdown placed constraints on the amounts that could be withdrawn. Flexible drawdown placed no restrictions, but was only available to those who satisfied the minimum income requirement, which required members to have a guaranteed lifetime income of at least £20,000 from state benefits, scheme pension income or lifetime annuities.

It is here – meeting the basic requirements of the majority of retirees – that the new regime will be most severely tested. Neither FAD nor UFPLS are on their own adequate for the effective management of longevity risk 

This ensured those in drawdown had a guaranteed lifetime income even if the defined contribution fund was exhausted before death.

It is worth noting that drawdown could be continued indefinitely; claims that mandatory annuitisation was not abolished until 2015 are false. 

In his 2014 Budget, George Osborne announced sweeping reforms to pensions drawdown. 

Existing constraints on withdrawals were removed; neither flexible access drawdown nor the new concept of the uncrystallised funds pension lump sum require members to demonstrate alternative sources of income.

Creating a lifelong income stream

The impact of Osborne’s reforms on what remains a relatively immature DC market has to date been somewhat limited.

FAD is a realistic option for those who have large funds; currently, this represents a small minority of members.

Those who have used the UFPLS option to withdraw their entire funds have tended to be those with modest pension savings and, for such individuals, this has probably represented the logical thing to do.

For some, the flexibility of the new regime presents attractive options. Benefits in the form of lump sums rather than an income stream will suit those with sophisticated retirement planning objectives. 

For the significant majority, however, the challenge at decumulation will be the same as it always has been: the conversion of an accrued fund into a lifelong income stream.

It is here – meeting the basic requirements of the majority of retirees – that the new regime will be most severely tested.

Neither FAD nor UFPLS are on their own adequate for the effective management of longevity risk. Ultimately, security in retirement will require a degree of annuitisation.

We would do well to learn from the experience of Australia. The pensions culture of that country has to date involved little annuitisation, and is now increasingly exposing its older citizens to the rude shock of poverty in old age.

To manage the problem, the Australian government is considering the introduction of a MIR. In the interests of prudence, would it not be sensible for the UK to do likewise?

Tim Middleton is technical consultant at the Pensions Management Institute