GAD rates are a vital point to bear in mind for pension investors, but few understand the meaning of the term and how GAD rates affect their retirement income.
GAD rates are calculated by the Government Actuary’s Department (GAD) with a formula based on investment returns for Gilts.
The government and pension firms then apply these rates to pension cash drawdowns to put a limit on how much income can be drawn each month.
GAD rates are reviewed regularly – and the first review since Chancellor George Osborne announced his radical overhaul of pensions in Budget 2014 is for May 2014.
Despite the excitement among retirement savers about earlier access to more cash and the chagrin of pension firms about having their annuity sales smashed, the GAD rate remains at 3%.
How GAD works
A GAD rate of 3% means a 65-year-old pensioner can take £5,900 income for every £100,000 invested in their pension fund each year.
To complicate matters, Osborne raised the GAD cap to 150% of the GAD rate. That increases the amount a 65 year old can draw from their pension to 150% of that £5,900.
In cash terms, that is £8,850.
Changing the GAD percentage alters retirement income pro rata.
Before Budget 2014, the rate was 120%, which let the same 65-year-old draw £7,080 a year.
So, increasing or decreasing the GAD rates and percentages impacts on how much a pensioner can draw from their fund each year.
Upping the rate means a larger income in retirement, while reducing the rate cuts the amount that can be withdrawn.
Temporary pension rules
It’s important to remember that the current pension measures are in place until April 2015, when new permanent rules will come into force. These new rules are expected to be in line with the temporary changes, but the details are still out for consultation before the final decisions are made.
Other points to bear in mind are the temporary rules only apply to defined contribution pensions, which are mostly private or workplace schemes. Public sector and civil service pension drawdown rules remain unchanged.
The Chancellor’s aim seems to be to let pensioners have easier access to their retirement savings and to put a framework in place to make drawing larger incomes available.
That’s why some critics have complained Osborne is encouraging spendthrift savers to draw too much from their pensions too early, which could leave them short of money in their later years.
Osborne’s response to that is to point out that people are responsible for their own retirement planning and once they have spent their savings, all that is left to rely on is the state pension.