The consultation to end compulsory annuitisation should lead to increased flexibility for retirees. Helen Morrissey asks if this is the case.
Since the coalition government came to power the retirement market has barely had time to pause for breath. Commissions have been formed to look at public sector pension reform and auto-enrolment and we've had an emergency Budget that ushered in long wished for reform of the requirement to purchase an annuity by age 75.
On July 15 the Treasury opened an eight week consultation on scrapping the so called Age 75 rule. Financial Secretary to the Treasury Mark Hoban said the move would "encourage people to take greater responsibility for their financial future (....) we need to give people greater flexibility over how they use the savings they have accumulated."
What's in the consultation?
Under the terms of the consultation document from April 2011 retirees can either choose to purchase an annuity or else go into either a capped or flexible drawdown system. The capped system enables income to be withdrawn subject to annual limits while those choosing to enter into a flexible drawdown arrangement can withdraw unlimited lump sums from their pension pot on the proviso minimum income requirements (MIR) have been met preventing them from falling back on the State.
The results of this change are that people get increased choice in how and when they take their retirement income.
However, it is a move that has divided the industry with some heralding the changes as having a huge impact while others say it will have little effect beyond those with extremely large pensions.
While TUC general secretary Brendan Barber said the annuity consultation was "irrelevant" for the vast majority of pensioners and pension savers Scottish Life's business development manager Fiona Tait was quick to disagree.
"Some people are saying that the changes won't affect many people but I think that is taking a very narrow view," she says. "The fact is that the flexibility on offer will affect how people make retirement decisions even if they don't actually use the drawdown options. For instance, we will probably find that the same people will continue to buy annuities in the future but the difference is that they will likely purchase them at a later date than they have up until now."
Hargreaves Lansdown head of pensions research Tom McPhail went a step further heralding the introduction of capped and flexible drawdown as "more radical than we expected but a very positive move for the vast majority of people."
Minimum Income Requirements
While these changes have undoubtedly brought increased flexibility to the market it is of course subject to several caveats. One major issue to be tackled during the course of the consultation is the definition of the "minimum income requirement" (MIR) the retiree will need to be able to demonstrate in order to use the flexible drawdown option. Factors to be considered are
• What constitutes "secure income"
• At what age should the MIR be met
• Level of the MIR
• How MIR should be assessed
According to the document only pension income can be considered as contributing to the MIR and so can include both the basic and second state pension in payment. Any further inclusions should already be in payment, be guaranteed for life and take into account "reasonable expectations of the future cost of living." Seeing as all of these are hallmarks of annuity it would seem this market still has plenty of bounce left in it though the report did state annuity income could only be allowed as long as it increases annually by at least the annual increase in prices or 2.5%.
Prudential's deputy chief executive Barry O'Dwyer agrees that many people could use part of their retirement income to purchase an annuity to ensure they meet their MIR target.
"Unless you have an occupational scheme that pays out a substantial income then you will need to buy either an inflation-linked annuity or else one that goes up by 2.5% per year," he says.
However, issues also exist for those looking to go down the capped drawdown phase. Current drawdown users can access income up to 120% of GAD limits but there are concerns such a limit will need to be revised for capped drawdown. So is there still a concern people could run out of money?
Burrows & Cummins partner, Billy Burrows says it is an issue that requires careful consideration.
"There is a concern that if we set minimums too high then people will take out more income than is good for them - we need to work closely to ensure the cap is set at the right level," he says.
However, McPhail does not agree that this would be an issue: "Retired investors tend to be quite conservative and the vast majority of advisers are very responsible," he says. "We feel that the limits on income to be taken in capped drawdown will be fairly conservative anyway so we shouldn't see people running out of money."
However, Tait cites concerns about the ability for retirees to take unlimited amounts in flexible drawdown leaving people ill prepared should they incur long term care costs later in life.
"I'm nervous that people may take out a lot of income in flexible drawdown having satisfied the MIR but then find they are hit with long term care costs in the future that they are unable to meet," she says. "Real care needs to be taken when setting out what constitutes the minimum income as we don't want people needing to fall back on the state for their long term care needs"
Another welcome outcome of the consultation was the abolition of alternatively secured pensions and its much maligned 82% tax charge which does not stack up well against the 35% charge levied against drawdown customers who die before age 75. Inheritance tax does not usually apply to unused pension funds remaining after death in addition to any recovery charge. Under the proposed changes any residual fund left on death within these new drawdown arrangements would be subject to a recovery charge of 55%.
Response to this charge has been varied with McPhail describing the increase as "proportionate." However, O'Dwyer believes the tax charge is punitive, particularly for basic rate taxpayers who choose to take up the drawdown options.
"If these people only got 20% tax relief on their contributions then it is unfair if they get taxed at 55% on death," he says. "What this demonstrates is that the proposed changes are only really open to wealthy people though I do understand the need to achieve some sort of balance between trying to be fair to everyone while also simplifying the regime."
What about small pension pots?
So while not everyone will be able to actively participate in the new regime in terms of accessing the different drawdown solutions it would seem that everyone will benefit from the increased flexibility in being able to purchase an annuity post age 75. Indeed, the consultation document was at pains to highlight that any changes should not undermine the annuity market as it will remain the primary retirement income for many people.
However it is likely these changes will herald a new wave of innovation from providers eager to offer new annuity ideas. One area likely to develop is that of value protection which enables retiree to ensure the remnants of their retirement income pot are paid out to dependants on death rather than being returned to the insurance company.
"The removal of restrictions to value protection is a very positive thing and will go a long way towards making annuities a more attractive product," says O'Dwyer. "I'm quite positive about the changes as I think they will stimulate the market for people coming up to retirement in the future."
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