In this month's Ask the Expert, Mike Morrison considers how the balance of flexibility and guarantees work best for retirement income.
One of the promises of both the Conservative party and the Liberal Democrats in their manifestos for the recent general election was the removal of compulsory annuitisation.
Compulsory annuitisation up to age 75 effectively existed until 1995, with the introduction of income drawdown (now unsecured pension or USP) and beyond age 75 with the introduction of alternatively secured pension (ASP) in 2006, although the rather draconian tax regime (potentially 82%) has meant this is an option that is rarely used.
An alternative option post 75 is that of scheme pension – another option that has previously existed for large occupational schemes and which has now been transposed across to a few self invested personal pensions (SIPPs).
Perception of annuities
The big issue is the perceived poor value and inflexibility of annuities and that people feel that they are ‘forced’ into the purchase of an annuity.
I guess it depends on whether you see an annuity as an investment or as an insurance product, insuring you against living too long. If you regard it as the latter, then the main thing is that it will pay out for the whole of an individual’s life, however long that might be.
For most people with relatively small pension funds, annuity purchase will be the only option as they need security and cannot afford to take any investment risk. However, more and more people are likely to seek a more flexible approach and if they have a large enough fund it might be possible to defer annuity purchase and use income drawdown in the interim.
One of the suggestions is that we could have a system post 75 that requires the securing of a minimum income, or earmarking of an amount that could be used to secure an income. This would be similar to the system in Southern Ireland where in order to enjoy full flexibility (an Approved Retirement Fund – ARF) it is necessary to have a guaranteed annual income of @12,700 per year from other sources than your ARF investment. If you don’t have this income, you must invest @63,500 of your pension fund into an Approved Minimum Retirement Fund – AMRF. Once you have put this money in an AMRF, you can put any remainder into an ARF.
A similar suggestion was put forward in the recent Centre for Policy Studies paper, ‘Simplification is the key’*.
“Post-retirement access to pension savings should be amended so that savers are free to draw down their assets as required (taxed conventionally as income), without any annuitisation requirement, provided that a minimum of £50,000 of assets (at the state pension age) is not accessed until the age of 75. Savers who have already secured an income equivalent to 40% of median earnings, say, from the State Pension, lifetime annuities or guaranteed private pensions, should be exempt.”
Level of income
A fundamental decision will be the level of income that needs to be secured. For example, is it calculated annually or indexed?
With such a mechanism comes the sting in the tail. If there is, say, the requirement to secure an income of a certain amount or to ringfence part of the fund, this is likely to restrict some people in their ability to use the new flexibility.
This would accord with the FSA in its Financial Risk Outlook** earlier in the year when it made the point that firms providing income drawdown, or advising on it, should bear in mind that it is unlikely to be appropriate for consumers with pension funds of under £100,000.
In the same publication, this is reiterated with its messages for consumers: those approaching retirement should be aware that if their pension pot is under £100,000 income drawdown is unlikely to be the most appropriate option.
The result of the consultation will be widely expected and anticipated, and I think that retirement options should be more attractive in the future. But we must remember that there is still a place for annuitisation and importantly, innovation, in that market.
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Industry Voice: For generations, life expectancy has been steadily increasing, with more and more people now likely to live to 100.