The troops have stormed the castle, the revolution is approaching its climax and the campaign to abo...
The troops have stormed the castle, the revolution is approaching its climax and the campaign to abolish the compulsion to buy annuities senses victory. But, before we do away with the present system it would be sensible to have something to replace it. Nobody has yet put forward a credible alternative.
There are only two ways to pay out income from a pension fund, one is an annuity, the other is drawdown. If annuities are out of favour, is drawdown in favour? One week the press are talking about the misery of annuities, the next week they will be talking up concerns about a scandal over pension drawdown. Surely it is time to have some joined up thinking and a proper debate.
Why is there almost complete silence from the pension industry and little support for annuities? A small group of us consistently put forward arguments as to why annuities are good value, but this receives a very small portion of the column inches devoted to this important matter. Recently, I wrote in support of annuities only to receive the response "Poor Mr Burrows, he would say that wouldn't he".
So why do I defend annuities? I say it is because of the many clients who have said to me: "You know that annuity was one of the best investments I have ever made." These were sophisticated clients who had often had annuities and drawdowns, so they knew what they were talking about.
This one-sided debate is very damaging. Not only are people more confused than ever, they are losing confidence in pensions and, most worrying, may end up making the wrong decisions.
Don't get me wrong, I am not trying to defend the indefensible. I believe it is time to call for the end of compulsion. Not because annuities are poor value for money, they provide very good value, but because the social and economic situation has changed considerably since compulsion was first introduced. If people want more choice, let them have it, but freedom is not licence. Along with greater freedom comes a greater responsibility.
At the heart of the matter is the position of the Inland Revenue. It argues that tax relief on pension contributions is given in order to provide pension income in retirement, and yet still relies on historic definitions of annuities, such as in the legal case of Foley v Fletcher (1858): "An income is purchased, the capital is gone, the principle having been converted into an annuity." It is therefore in favour of schemes that allow members to take their entire funds as a lump sum or to pass the capital to their dependants. Although the Revenue has bent over backwards recently to allow for a more liberal definition of an annuity, it is constrained by the existing legislation.
I believe there is a very simple solution. My proposal is that pensioners should be allowed to continue with a form of pension drawdown after the age of 75, subject to two rules. The first is that at age 75 there should be a requirement to purchase a minimum level of annuity to ensure that people have sufficient income so as not to be a burden to their family or the state. The amount of annuity is open to debate but should be set at a level that does not unduly disadvantage those with smaller funds or limit their options.
The second rule is most important. Pensioners should only be allowed to continue making income withdrawals if they are subject to rules that regulate how much income should be taken. I have in mind limits that are similar to the minimum distribution rules that apply to 401 K's in the United States. They have a very simple formula for calculating this minimum distribution. Every year, the amount remaining in the pension fund is divided by the life expectancy, and because each year life expectancy decreases by less than one year, the policyholder will not run out of income.
The point is that the Revenue should be happy that people are using their pensions to provide income and it gets its tax. Pensioners would be happy because they would have more control and flexibility, and the politicians should be happy because everybody else is happy.
There are drawbacks to this approach. What happens if the fund does not grow as predicted and people live longer than expected? Surely, the point is that if people want more choice they must be prepared to take more risk. In any case, they will already have invested part of their pension in an annuity. I would argue that many people will still be well advised to purchase an annuity well in excess of any compulsory minimum, and many may wish to combine annuities and systematic withdrawals to achieve a tailor-made retirement package.
William Burrows is a director of Morestead Retirement and askannuity.com
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From 1 March