UK pensioners set to lose out with scrapping of annuity system, experts warn

News - Savings

Written by Ray Clancy

Friday, 10 December 2010 09:18

The end of compulsory annuitisation gives more flexibility but it could cost UK pensioners thousands, according to experts.

The government’s decision today to scrap compulsory annuitisation at the age of 75 should be treated with caution, said Craig Fazzini-Jones of MGM Advantage, the retirement income specialist.

The new draft legislation, as part of the Finance Bill 2011, aims to change current rules that stipulate individuals have to take an income from their pension fund from the age of 75.

‘While anything that gives pensioners more flexibility is a good thing, people should not lose sight of the value an annuity can bring. Indeed, each year somebody delays annuitising represents a year’s lost income that could take years or unfeasibly high returns to make up. The longer a person lives, the more they earn from their annuity, and the more they benefit from those who don’t live as long,’ explained Fazzini-Jones.

‘This concept is called mortality cross subsidy and is often ignored because the conventional annuity builds it in to the income rate at outset, when the annuity provider predicts how long the customer will live. The benefit is then spread in equal measures across the lifetime of the annuity to provide a level and guaranteed income, which makes it invisible to the individual, and perhaps not fully appreciated,’ he added.

He also pointed out that if a person buys an asset backed annuity, the value of the mortality cross subsidy becomes apparent as it is added as a bonus each year and for a 77 year old, this annual bonus could be as much as 2%. ‘One of the arguments behind scrapping compulsory annuitisation is that it if somebody dies earlier than expected, they can leave their pension fund in their estate. It is worth noting that only around 12% of 60 year old men today will die before they are aged 75, and this is likely to reduce further. So for many, it is a big gamble to trade a lifetime income for the probability of dying early,’ he said.

Stephen Berry, tax specialist at insurance, pensions and investment specialist NFU Mutual, said the changes, which come into effect in April 2011, will bring greater financial control to people at the age 75.

‘Taking away the age ceiling for most lump sums, and removing the need to buy an annuity from a Direct Contribution scheme, will create greater flexibility for pension holders,’ he said.

But he warned that one of the less favourable changes is the decision to increase to 55% the tax rate on all lump sum death benefits, other than for those who die without taking a pension before age 75. ‘We hope it will be afforded extra consideration during the consultations on these proposals taking place until 9th February 2011,’ he added.

However, the Saga Group described the changes as a huge tax cut for the wealthy and will mean the middle class subsidising top earners’ pensions. ‘The Government’s annuity proposals benefit the wealthiest enormously but at the potential expense of the middle classes. This means that pensions are even less attractive now to basic rate taxpayers,’ said Dr Ros Altmann , director general of The Saga Group.

‘The Government says the current rules are unnecessarily restrictive, but this is really only the case for the very wealthiest few percent of pension savers. For most people, the problem is very different, it is one of inadequate and ineffective regulation of the annuity sales process and the proposals will not help the majority of pension savers,’ she explained.

‘Indeed, for many, the proposals will result in worse outcomes, as they will increase the tax rates on those who cannot afford to leave their pension funds untouched until age 75 and die in drawdown, as well as risking worsening annuity rates if more people try to annuitise to secure their MIR at younger ages,’ she said.

‘The pensions crisis and annuitisation problems affect middle or lower earners most, not the wealthiest and it is these people for whom policy should be ensuring pensions work better. The current proposals do not address the most significant failures of the existing system,’ added Altmann.
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