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Adding complexity

Until a few years ago annuities were said to be “commodity” products – simple and straightforward, like term assurance.

Potential annuitants, having built up their retirement funds, would shop around for the best annuity to suit their circumstances. They were compared with term assurance because people needing life cover would know exactly what type, amount and length of protection they needed, could easily compare premium rates in newspaper columns and then make their own decisions.

Both propositions were flawed. Would level-term assurance be sufficient or would decreasing, renewable and/or convertible term be more suitable? Are the premium rates guaranteed or reviewable? What type of annuity is right for the individual – level, increasing, single life, joint life, with-profits, impaired life? Should annuity purchase be phased over a period or would drawdown be more suitable?

In recent years there has been significant innovation in products. In practice, the decision as to the most suitable annuity is one that needs advice: shopping around on your own can be expensive.

The problem is that many potential annuitants do not shop around to obtain the best annuity rate and can end up tied to a provider that pays an annuity, say, 10 per cent lower than the best provider.

According to the Consultative Document “Modernising Annuities” published by the Department of Work and Pensions and the Inland Revenue”, only 30 per cent of members take advantage of the open market annuity and 43 per cent have funds of less than £10,000.

In future, providers will need to do more to encourage the use of the “open market option” by scheme members in the months leading up to retirement (following the ABI&#39s Statement of Good Practice for Pensions Maturities).

However, some people will still not take advantage of this option because they cannot be bothered to shop around and perhaps because they feel that a 10 per cent increase, say, is still not worthwhile when they have only a small fund to transfer on the market.

Those who do shop around and secure for the best annuity rate may not end up buying the right type of annuity for their circumstances. Unfortunately, those with small funds will be unable to afford the advice they need. There must be a place for simple decision trees for these people because once an annuity is bought there is no going back, currently.

However, the consultative document also contains proposals that should give annuitants more flexibility (though they are unlikely to appeal to those with small funds). The proposals include the facility to transfer the liability to pay an annuity from one provider to another, and to allow limited period annuities.

The former could result in complaints about the amount of the transfer value and transferring annuitants may be faced with having to provide evidence of health before being able to transfer. So, the ability to transfer annuity providers could be limited to certain predetermined points in order to reduce the impact of selection against the provider.

Limited-period annuities could be of interest to those who do not wish to tie themselves into buying an annuity for life when their circumstances will change during retirement. For example, someone may not require the maximum annuity when they have another source of income from, say, a part-time job.

After a period they may retire completely when they could look afresh at their circumstances and then buy another limited-period annuity. However, at age 75 they would have to buy an annuity for life.

Overall this proposal will give greater flexibility, although retaining the age 75 date for final annuity purchase will disappoint some who had hoped for its extension or abolition.

There are risks that people will not be able to maintain the right level of income with what might remain of their retirement pots at an advanced age and risks that the state has to provide support. There is also the fact that tax advantages granted to pension schemes during the accumulation phase are designed to provide income in retirement benefits, not estate succession planning.

There will be additional costs involved in buying a succession of annuities, perhaps with different providers. There will be paperwork in arranging the transactions and each occasion will bring about the need for advice in relation to the client&#39s circumstances.

Annuities were never simple and straightforward. These proposals, while they could bring greater flexibility, will also create more complexity – and the need for advice.

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