The coalition government announced its intention to change the rules governing pension income early on, immediately pushing back the age for compulsory annuity purchase from 75 to 77.
In fact, there is no current requirement to buy an annuity at 75 but there are complex rules for those who wish to continue to defer annuity purchase.
Pension rules are really determined by the official view that an annuity is preferable to drawing an income directly from the investment fund within the pension. From the government’s perspective, there are some good reasons to favour annuities. The income is secure and there is no prospect of it running out before death leaving the state to pick up a higher benefits bill. The pensioner has also said goodbye to their pension fund so there is no chance of them starting to resent the fact that their nice fund will not pass on to their children.
However, annuities are not perfect and during the nineties the rules were changed to allow drawdown of the fund, mainly because annuity rates were falling at the time and it was hoped that they would recover (some hope!) and, therefore, deferring purchase would be helpful. Since then, of course, headline annuity rates have continued to fall as a result of persistently low medium term interest rates and increasing life expectancy. Index linked annuity rates for those in good health in their sixties are stuck around the 3% or 4% level, which means pension funds have to be that much bigger than before.
For those taking out an index linked annuity, their main concern, and about the only risk they face, is dying too young and getting poor value from their capital.
Someone retiring and willing to take more risk has the prospect of a higher level of income, initially at least. If you can live with the risk of inflation eroding your income, a level annuity can provide an income which could be nearly double that of an index linked annuity at outset. However, if inflation rears its ugly head, you could find yourself entering your most vulnerable years with a much reduced standard of living. Falling back on the mercy of the state towards the end of your life is hardly an appealing prospect for someone who has saved hard to avoid it.
The alternative (and the main object of the government’s attentions in this review) is to draw an income from the investments directly. This is risky, expensive and complex but does offer the potential for a higher level of inflation protected income coupled with a great deal more flexibility. It was never intended to be used without professional advice nor was it seen as a mass market solution. It has, however, proved popular and is set to become increasingly so.
So, the government has now set out to see whether some of the annoying and seemingly petty restrictions can be removed in return for a degree of protection for the state, we don’t want the risk takers back with their begging bowl if they have blown all their cash.
In any case, pensions may become more attractive to investors than they are at present.
