Annuities facing new-age reforms

Annuities face close scrutiny in the coming weeks. The Inland Revenue is issuing a consultation paper by the end of the year, as announced in the Chancellor's pre-Budget report, and the Rt Hon David Curry MP launches his Pensions Annuities (Amendment) Bill next week.

Annuities, the guaranteed income for life which must be bought with three-quarters of your pension pot by the age of 75, have fallen out of favour.

Rates have nearly halved in the past decade: a £100,000 pension fund bought a 65-year-old man an annuity of about £15,000 10 years ago. Today he would get £8,000, the result of lower interest rates and improved life expectancy.

Annuities are also unpopular because once you have bought one, you are locked in for life. You also don't have much say over the timing of the purchase.

Mr Curry aims to reform retirement income by removing the obligation to use pension savings to buy an annuity at the age of 75. Instead, he suggests those retiring need buy an annuity to meet only a minimum retirement income, set by the Government, allowing the rest of the pension to be re-invested in a retirement income fund. The amendment Bill also introduces the ability to pass on residual pensions savings on death through inheritance.

But the Treasury is unlikely to be so radical in its aims. Instead, it will probably focus on transferring annuities so relatives get some benefit from the deceased's lifetime of saving.

"Annuities still do something no other financial investment can, guarantee an income for the rest of your life," says Tom McPhail, head of pensions at independent financial adviser Torquil Clark. "Instead of abolition, the Treasury is pushing towards transferable annuities. The reform on death benefits makes a lot more sense."

Annuities are particularly inflexible for people who have built up a sizeable pension pot. "For those with small pension funds, and those people retiring with modest prospects, annuities are their main financial tool," says Mr McPhail. "For larger funds, if you can afford flexibility and risk, the question of inheritability becomes much more important."

Most advisers agree that annuities need modifying, although few are prepared to recommend abolition. "They aren't such bad value for money but they are not appropriate for everyone," says Helen Symonds, manager of the independent arm of Punter Southall Financial Management. "What the Government needs to do is give people choice. I don't know why the magical number of 75 was plucked out of the air, but it doesn't bear much relation to how people live their lives.

"In its consultation, the Inland Revenue might extend it and might build in some sort of premise that you have to meet a basic support level and guarantee it with an annuity. But you can choose what you want to do with any funds above that."

But Donna Bradshaw, director at IFA Fiona Price & Partners, says raising the age could be a waste of time in the long term. "From 2006, we could well see the introduction of EU legislation which means that the Government can't set an upper age limit [before you have to buy an annuity] because it is age discrimination," she says.

No matter what reforms are eventually introduced, one of the most important things that people can do to help themselves is shop around for the best annuity rate. Annuities can be purchased on the open market; nobody is forced to buy one from their pension provider.

"Most people do not shop around for the best deal on their annuity," says Ms Bradshaw. "Yet this can make a significant difference to their income in retirement, as much as 20 per cent, and many are losing out."