Pension Annuities, Pyromania and Ethel the Frog

Neil Copeland

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The first time I saw Def Leppard the drummer still had both his arms.

Not many bands visited remote outposts like Belfast back in the early 80’s and we were mightily supportive and indeed grateful to those who did, like Def Leppard. The band had already released a couple of albums but this was the start of the tour to support Pyromania, the album that was to push them into stadia around the world and was a precursor to their absolutely mega-album Hysteria. They put on a great show that night and, indeed, as an ageing rocker, I can attest that they still do.

But, as with many bands, global success will alienate that small sub-group who only ever like a band if no one else has ever heard of them. You know what I mean – the guy or girl who goes “Yeah I saw them in a pub in 1980 when they couldn’t play their instruments and it was only me and my dog in the audience, and they were sohhh cool, but now, like, they’ve just totally sold out and are rubbish. I’m really into Ethel the Frog now”. Luckily for fickle fans everywhere Ethel the Frog were never a success. Not so lucky for Ethel the Frog.

The Governments proposals on the abolition of compulsory annuity purchase seems to be subject to some equally fickle fans, if a recent article in the FT is to be believed.

For years one of the alleged barriers to pension saving was the fact that people really didn’t like the idea of handing they money over to an insurance company only to die the next day, leaving the insurer with a large profit at their expense. The reality is that the risk of this has been overstated, and the risk of you running out of money before you die understated, but the cacophony from all parts of the industry calling for the abolition of compulsion in this area was deafening.

But already prophecies of doom are appearing, as in the FT article, suggesting that we’re all bound for destitution because of the Government’s proposals in this area. So what exactly are the proposals which represent the next great threat to civilization as we know it?

  • There will no longer be a requirement to purchase an annuity, at any age.
  • The ASP regime will be abolished.
  • Scheme members will be entitled, but not obliged, to drawdown an income from a scheme, within minimum and maximum parameters.
  • The 25% income tax free lump sum entitlement will remain.
  • The scheme value of a member who dies before age 75, and without having drawn benefits, will continue to be tax free.
  • The scheme value of a member who dies when aged 75 plus, or at an earlier age when the scheme is in draw-down, will be subject to income tax. This recovery rate is proposed to be 55%.
  • There will be no inheritance tax charged on the value of schemes.

Personally I think compulsion by the state to behave in a particular way is justified only where it is necessary to prevent physical harm to others. So clearly I consider the abolition of compulsory annuity purchase to be a good thing. Giving people choice and control over their retirement planning is a good thing. Removing a barrier to retirement saving is a good thing.

But there is a risk that when you offer people choice, they will inevitably make the wrong one. That is why professional retirement planning must be a key part of any retirement strategy – and I do have some concerns in this area about the information and support being provided, particularly to members of occupational DC schemes.

Even something as simple as raising members awareness of the availability of an open market option in occupational DC schemes has the potential to deliver improved income in retirement for members. But the evidence suggests that even this basic step is poorly communicated and understood. The Pensions Regulator has made it clear that governance and trusteeship of DC schemes will come under increasing focus, primarily aimed at ensuring members make the right choices at retirement. This increased scrutiny is likely to highlight the fact that there is every bit as much a role for professional trusteeship in the DC environment as in the DB environment. Furthermore, there is often no access for a member to Independent Financial Advice in the occupational DC environment. Member communication and education in occupational DC schemes needs to be improved as a priority.

We also need to ensure that the advisory process is fit for purpose in terms of steering members through their complex options to identify the one which best suits their personal circumstances.

It is important to remember that the Government is only proposing to abolish the compulsory purchase of annuities, not annuities themselves. In the same way that advisers recognise that income drawdown is not an appropriate solution for everyone they will recognise that the new non-annuitised regime is not for everyone either. It is likely that advisers faced with members who have a need for guaranteed levels of income and who want to manage their mortality risk will continue to recommend annuities as part of a range of retirement solutions.

Given this it is likely that the abolition of compulsory annuity purchase poses as great a threat to civilization as the 2009 swine flu “pandemic”.

Neil Copeland

Post by Neil Copeland

Director, pensions consultant and adviser to trustees and employers on all aspects of work based pension schemes.