Budget scraps rule that makes annuities compulsory at 75
Pensioners now have more choice as to how to fund their retirement. Chiara Cavaglieri explains the pros and cons of the different options
Sunday 27 June 2010
After months of speculation, the coalition government announced in the emergency budget that it would scrap the rule that makes it compulsory to turn a pension pot into an annuity by the age of 75.
The rule change comes in next April, but the age limit has been raised to 77 with immediate effect to draw in those turning 75 before April. The tax payable on a pension pot on death has also been reduced to 35 per cent, ahead of a consultation detailing the changes.
Under previous rules, people reaching 75 had two options; they could either buy an annuity or take an alternatively secured pension (ASP). With the latter previously incurring a punishing tax of 82 per cent on death, most people opted for an annuity.
"The prospect of being forced into a decision with their hard-earned savings was a major psychological barrier that has prevented many people from pension saving. The new rules will allow people to have a lot more flexibility regarding what they do with their pension pots and, more importantly, when," says Hugo Shaw, an investment adviser at independent financial adviser (IFA) Bestinvest.
Savers will now have the choice of either buying an annuity as before, or continuing to run a drawdown plan past the age of 75. With an income drawdown plan, you can take a tax-free lump sum of 25 per cent but the underlying fund can be invested as you see fit, so that it continues to grow.
The benefit of income drawdown is that you can continue to invest and grow your pension, and take an income from it as you need. You can turn your income stream on and off at any time which makes it ideal for people who retire gradually. However, while you can benefit from any increases in the value of the fund, you also run the risk of losing out if the fund value falls. This may become more of a concern as you get older, and so becomes a less attractive option after the age of 75.
It is also unknown at this stage what restrictions the government will put in place, once it has formulated more permanent rules. "They could require people to secure a minimum level of annuity income, perhaps £6,000 a year, and then give them the freedom to do what they like with the rest; or they could impose new drawdown income rules to ensure people couldn't run down all their retirement funds," says Tom McPhail from IFA Hargreaves Lansdown.
Those with a larger fund can expect to benefit the most from the new rules, because they now have far more flexibility as to how to invest their money. Annuity rates have been falling for some time, making them far less appealing. A man aged 65 buying a "level" annuity (that doesn't increase with inflation) with a £100,000 fund would have received an income of around £9,000 a year in 2000, whereas today they would get around £6,450.
Most people take out annuities long before 75, because at that point their life expectancy falls to close to 10 years, and they would struggle to find an annuity rate that would pay out as much as their capital over that timespan. Also, many people buy their annuities from their pension providers, instead of shopping around for the best deal.
Another problem with annuities is that, unlike income drawdown, you no longer have control of your money. In many instances, your partner or dependents are unable to benefit if you die, and the remainder of the fund goes straight into the insurer's pocket.
"The detail we have yet to see is whether this removal of the age 75 rule will include the introduction of a 'money back guarantee' annuity option. This would allow anyone to protect their pension savings from the financial impact of dying early," says Barry O'Dwyer, below, the deputy chief executive of Prudential.
Despite the potential pitfalls, annuities still have their proponents: "For most people, annuities are the most effective way of providing a regular income stream in retirement. For those who need to maximise their income in retirement the debate remains about when to annuitise, not if to annuitise," says Mr O'Dwyer.
Tom McPhail, Hargreaves Lansdown
Investors have long been averse to relinquishing control of their savings by buying annuities and this has deterred people from pensions.
Scrapping the rule that requires pensions to be turned into annuities is a game-changing development because it means that people have control; the more you save in your pension fund, the more freedom you will have and the more control you'll have over your retirement funds.
Even though most people will still end up with an annuity, this will improve the pensions landscape for everyone.
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