“We fell out of love with annuities because we were made to buy them too young”

26th March 2014

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Whatever your political persuasion, you have to take your hat off to Chancellor George Osborne for the way he has completely redefined the UK’s approach to pensions writes pensions journalist John Greenwood. That he has achieved this without any consultation, presenting his plan to the world fully formed and then seeing it pretty much accepted across the board is equally remarkable.

Of course political self-interest will have played its part. Millions of over-55s will, in the 14 months between now and the General Election, have access to cash that was previously beyond their reach.

But Osborne can rightly claim that the policy is rooted in Thatcherite principles of a small state and personal responsibility. It took Labour three days to work out its position, but over the weekend work and pensions shadow Rachel Reeves finally came out in support of the policy. She had no option – with the annuity market surrounded in such controversy, how could Labour argue against people’s right to choose what to do with their own money.

The Government’s ‘treating people like adults’ argument is slightly disingenuous, given that it is in the middle of a massive project to try and make 10 million workers save into pensions.

And there has been much hand-wringing amongst those in the pensions industry who do think the public need to be told what to do with their money, which is not surprising given this has been the position of successive governments for decades.

Osborne’s pension revolution has raised concerns that people will blow the lot, on beer, bingo or maybe a Lamborghini, as suggested by pensions minister Steve Webb – surely a quote that will come back to haunt him.

Some will, it is true, and despite the introduction of the new single-tier pension from 2016, many millions of pensioners will end up on means-tested benefits for decades to come. This number will surely increase as people run through their cash more quickly than they had expected.

And in any event, you have been able to cash in your pension for years if it is less than £18,000 for years, yet nobody complained.

Fears have also been raised of people being ripped off when they come to spend their pot. Yes, this will happen, as it does in all markets, and the government and regulators must do all they can to minimise this. But the annuity market we are leaving behind was one of the worst-functioning markets this country has ever seen. Surely anything has to be better than that.

But crucially, the Osborne pension reforms mean the money we save for retirement will in many cases be put to far better use. One in six retirees is in debt to the tune of an average of £24,000, according to research from Prudential.

The interest on £24,000 of debt is always going to be considerably higher than the annuity that sum would buy. For these indebted pensioners it is good maths to clear debt before making further investments.

For those with money to invest, we will now see providers designing new structures that will bring the benefits of income drawdown to the mass market, but without the big costs of a financial adviser reviewing the portfolio every few years. If you can afford to live with some fluctuations in your income, these products are statistically likely to give a better return than an annuity, with, of course, the caveat that they might not.

The Government has raised the point that in Australia and the United States, people are free to draw cash from their pots, yet they are generally responsible with their money. This is true, although some American and Australian pensions professionals have expressed surprise at the UK’s decision to liberate pension cash. In these countries the debate is going in the other direction, with governments trying to get savers to think more long term.

One of the problems in the US is that some people spend too little, for fear of running out of money. This is where the oft-maligned annuity comes to the rescue. Annuities are generally a poor deal between age 65 and 75 because the return you get is not benefiting from the fact other people in the pool are dying – what actuaries call politely the ‘cross-mortality subsidy’. But as you get into your late seventies and your chances of slipping off this mortal coil increase, the annuity rate you get increases substantially.

We have fallen out of love with annuities because we have been made to buy them too young. The annuity is not dead – it is just something most of us will buy much later.

Of course political self-interest will have played its part in his decision to give retirees access to their pension as a cash lump sum rather than taking it as income.

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