A default annuity option could be added to personal accounts as the government is switching its focus onto the decumulation phase of the retirement income system.
At a meeting held by the Department for Work and Pensions (DWP) on Wednesday, civil servants and industry representatives discussed the best ways for members to deal with the transition of their pension funds into annuities or drawdown.
The meeting offered strong support for the open market option (OMO), suggestng almost everyone holding a personal pension account who then reaches retirement should go through some kind of OMO process where they can shop around for the best annuity rates.
But individuals attending the meeting acknowledge default members of the schemes - those people who are auto-enrolled and who fall into the default fund without making any active choices - are also unlikely to engage in the annuitisation process.
As a result, the government could consider the introduction of a personal account default annuity option, with perhaps a handful of insurance companies competing to act as one of these default providers.
Details of how this might work are still at the discussion stage, although there are suggestions it could either be done competitively on price or a carousel of providers could operate by meeting set price requirements.
But attendees of the meeting also agreed there would be a need for strong communication and information to members of the scheme, to ensure they exercise their choices, and which could entail them being walked through the process step-by-step to make it as painless as possible.
One way of doing this within the framework of personal accounts would be to set up a panel of OMO annuity advisers which could offer advice on a streamlined basis, so instead of the normal cost of £300 or more - which means people ar more likely to purchase annuities on an unadvised basis - the cost could be brought down to around £100.
That said, the system would also have to be flexible enough to accommodate people who want to go into drawdown or who may want to use their own financial advisers.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says the decumulation of pensions is a surprisingly complex area with a number of issues to consider.
He says: “When looking at the end process, as an entirely new system personal accounts could have an entirely separate annuitisation process to the rest of pensions. But the problem is if members are not offered exactly the same products as the rest of the market, personal accounts could begin to be seen as the ‘poor relation’ of pensions and everyone will opt out.”
There are also some issues of trivial commutation which need to be reviewed, says McPhail, as some people, through opting-out and changing circumstances, could end up with a personal accounts pot of around £200.
Current rules require if an individual has retirement funds elsewhere which total £15,000 or more, this £200 will have to be converted into an annuity, a move which is pointless for all concerned, says McPhail, as even a £1,000 pot will only generate income of around £1 a week.
"Some of these issues are no doubt be subject to further debate, but so so far most of the attention has been on the savings part, so its good to see some focus moving to the back-end processes," says McPhail.
Rachel Vahey, head of pensions development at Scottish Equitable, adds it is very interesting the government is beginning to focus on the decumulation process, but she says it is up to the industry and government to work together to educate people and ensure they make the right choices.
She says: “The idea of a default annuity option is something which probably needs to be batted around a bit more, as we really want people to make an active choice on decumulation as it’s a very important decision on how you receive income through retirement.”
Vahey points out accumulation of a pension is the easiest part, particularly with auto-enrolment, but decumulation is a difficult experience for people in working out what has the best rates, and whether annuity or drawdown is the best option.
“Decumulation is really a medium-term problem, rather than an immediate one,” says Vahey, “as it is at least 10 to 15 years before people - saving solely through personal accounts - will look at decumulation. But that doesn’t mean we shouldn’t be discussing it now, as we still need to look at other options not just for personal accounts but in a wider sense.”
John Lawson, head of pensions policy at Standard Life, says he hopes the government doesn’t decide to constrain the decumulation process of personal accounts too tightly, as although a default annuity option would be one possibility, there are also other income options.
He suggests the government consider the adoption of guaranteed living benefits (GLB), schemes which have become very popular in America, as although it costs an extra 0.6% charge on top of the annual management charge, it offers a guaranteed income at retirement, underpinned by futures and securities, while still investing in equities.
“This would be ideal for those holding personal accounts, as the key iddur is how much income an annuity will provide in retirement,” says Lawson.
“With these types of GLB product, by investing in equities they are likely to have a return above their guaranteed income, but if equities don’t perform well then they know what the worst case scenario would be.”
While the DWP’s current discussions don’t seem to have moved past the actual annuity buying process, Lawson says while there are practically no GLB products available in the UK, the concept is already around in capital-protected structured products and could be easily adapted for pensions.
He says: “The DWP seems to be keen on putting a dividing line between the accumulation and decumulation processes, but it should be wary of trying to shoehorn everyone into lifestyling default funds, when they may not necessarily be better off in that product.”
“Hopefully, there will be scope for more innovation rather than just annuities, as that would just create more pressure on the gilt and bonds market. We just have to wait and see what the DWP decides to take away with it, and what shape comes out,” adds Lawson.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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