Personal finance: It's time we end this annuity woe

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The Independent Online
AS PART of the unending search to remove barriers to long-term savings I believe the time has come to abolish the compulsory retirement annuity pensioners buy with the proceeds of their accumulated pension funds when they retire.

The trouble with most annuities is that once you buy one they are fixed for the rest of your life, leaving you with no protection from fluctuating interest and/or inflation rates. As people retire earlier and live longer they can be exposed for 20-30 years. Not so long ago the main threat came from inflation, which begins eroding the value of the annuity the moment it is first paid.

Nowadays however it is deflation and falling yields on gilt-edged stock that are the main threats to people reaching retirement.

Standard annuity rates have halved since 1990, and at current rates anyone buying an annuity locks in a low return for life and remains at risk if inflation does return at a later date.

There are two ways of avoiding this trap. One is to buy an annuity which grows at a fixed rate of 3 per cent or 5 per cent a year or in line with inflation, although the amount you receive is much smaller in the first few years.

It may take up to 14 years to catch up with a level annuity, and longer still before you have recouped all you lost in those early years.

Whatever the size of your annuity it is also a fact that the moment you buy an annuity you have lost your capital. The best you can get is a guarantee of five years money and a pension for your surviving spouse if you die immediately but to get the very best annuity rates you have to do without those benefits, which means if you die your pension and your capital have both gone for ever.

The only way to get a retirement income and keep your capital is to take out an income draw-down plan instead of an annuity. Income draw-down plans allow pensioners to draw income and delay buying an annuity. They cannot delay indefinitely however, and in order to prevent pensioners running down the capital and then turning to the state for support the Government limits the amount that can be taken from a draw-down plan each year.

Also not many people can afford to take the lower starting income, and advisers can charge fees of up to 5 per cent of the funds invested, plus an annual management fee. Most advisers say that if you have less than pounds 100,000 in your pension pot at retirement you should forget it.

For the great majority of people reaching retirement there is no alternative to buying an annuity at the best rate you can find, which is small comfort if you are unlucky with the timing. The next step to encouraging an effective pension policy is to allow everyone reaching retirement to keep his or her pension pot and introduce a low-cost CAT-marked draw-down plan to accompany the proposed CAT-marked stakeholder pension. The Chancellor could do worse than make a start on Budget Day.