Pensions Management article on trustees and annuity reform

by Dr. Ros Altmann

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The issue of compulsory annuitisation almost derailed the entire Pensions Act last year, so this is clearly an important topic. Annuities are a 'special case' in the financial products arena. Government forces most people to buy an annuity with their accumulated pension savings and once bought, it cannot be changed. Shouldn't Government, therefore, help ensure people can buy the right annuity for their own circumstances, at a competitive rate? And what is the responsibility of DC scheme trustees when it comes to annuity purchase? Have they been acting appropriately and ensuring members receive the right annuity and top rates?

Annuities are an excellent idea for providing lifelong pensions. But the majority of buyers find them complicated and need help to understand them. However, it is generally only those with large capital sums who actually get any advice. Almost all other annuitants are left to make this daunting decision on their own. In theory, there is the opportunity to take an 'open market option', which allows people to 'shop around' for a better annuity than the one offered by the company who managed their pension savings, but, in practice, this entails filling in so many forms, that people are put off. It is actually much easier not to take the open market option, as all this requires is ticking the box on the form provided by the pension company and sending it back. The result is that people often end up with the wrong type of annuity, or get a poor rate, or both. The difference between best and worst annuity rates can be 20-30%, and even more for those in poor health. This is a cause for concern.

I think it is vital that Government ensures everyone considers, with a specialist adviser, the few basic questions they need to think about before buying their annuity.

  • Could they qualify for enhanced rates?
  • Should they cover their spouse?
  • What about inflation-protection?
  • What guarantee period?
How would such a specialist advice system work? The FSA would need to approve a particular type of advice for annuity purchase, (without the normal 6-hour full fact find); just answering the few vital questions. The retiree would have someone to help them understand the important issues when finding the right type of annuity and then find the best rates (choosing from one of the top 5 perhaps). With a specialist, this exercise would be easy. For each individual, it is often impossible. The FSA produces useful annuity information and decision trees can make any advice process easier, quicker and cheaper, but decision trees and leaflets are not enough. People need someone to talk through the relevant points, before making this irreversible decision.

If the person's circumstances are simple, (often they have no other income apart from the state pension and could not consider investment-linked or other annuities) this should be enough to select the right annuity. If their circumstances are more complex, they would be told to take more advice.

Specialist annuity advice should not take too long and charges could be levied on a fee basis, with perhaps a minimum of £100. The key point here is that the cost of advice is already potentially included in the product - up to 1.4% is currently deducted on annuity purchase anyway, whether an adviser is used or not. Even a £20,000 capital sum, could provide over £280 to cover an adviser's fee.

As defined contribution pensions spread widely, if mandatory annuitisation remains, urgent action is required. Government has already announced some useful reforms, starting in April 2006, when those who saved under £15,000 can take a lump-sum rather than an annuity, but providing advice for all annuitants would be a significant step forward. Ensuring retirees consider the vital questions before purchasing their annuity, could make many pensioners, typically those with moderate capital sums, better off for the rest of their lives. At no cost to Government.

So far, annuitants do not seem to have realised they may have bought the wrong product, but how much longer will it be before we see the first complaints from people who find Government forced them to buy an annuity, over 1% of their pension savings was deducted as 'commission', yet they had no adviser to help them make the right choices? If they buy the wrong type and have to live on a much lower income than they should - but can never do anything about it - would they think Government was overseeing the annuity system appropriately? What about trustees of DC schemes who may not have taken sufficient care to secure the right annuities for retiring members? If the trustees did not select an impaired life annuity for someone in poor health, or did not buy from a top-rate provider, will they find it easy to defend a future challenge from a member or their family? Could this be another pension scandal? DC trustees beware - annuity decisions must be taken with care.

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