As well as focusing on how to force all employers to automatically enrol their employees into a pension scheme and contribute at least 3 per cent of salary, there have also been some interesting discussions about how to ease the burden for employers with defined-benefit pension schemes.
The debate is set to widen once the Bill moves to the Lords, as the Conservatives are going to table an amendment to the Bill calling for an end to compulsory annuitisation.
There is no doubt that the decumulation – or pension harvesting – rules are in need of an overhaul. Currently they are set too rigidly, following a blueprint designed too many years ago, when retirement patterns were vastly different to today.
Consequently, they do not do as well as they could the job they are designed for – to provide people with retirement income solutions that match their income needs. People could spend a third of their life in retirement, and need to adjust their income levels to match their outgoings. Furthermore, these tight rules could be instrumental in putting people off saving in pensions to start with.
However, annuities play an important part in retirement planning – as longevity insurance. They provide the security that, regardless of how long you live, the annuity provider will carry on paying instalments. Annuities are one of the most competitive pension products and, coupled with the correct advice on both shape and provider, can deliver a good retirement deal for many.
Annuitisation is not compulsory. Those with little pension savings can exchange the full pot for cash, under the trivial commutation rules, as long as certain criteria are met. And for those who can look elsewhere for their basic income needs, or who are willing to risk more, there is income drawdown.
Where annuities may fall down is that their design has not kept up with people’s changing needs. The idea that someone’s income needs are going to remain constant for their 30 years of retirement, or only go up, is at odds with reality.
Annuities should be able to both increase in value each year and fall back in periods when people are living quieter lives and need less disposable income. We must also examine if there is some way annuities can provide for an emergency call on funds. For example, when money has to be found from somewhere because of a catastrophic change in someone’s health.
The retirement income market is aware of this changing landscape and is busy designing new products. Providers have started entering the middle market area offering solutions that sit somewhere between the stark choices of annuities and income drawdown. These offer both a guarantee and a chance to benefit from any good investment performance.
The Government, however, is reluctant to introduce more flexibility into the rules. Central is its concern that people will only save in a pension to pass the money down to other generations, rather than to provide themselves with an income. Certainly, most people would prefer it if their children could benefit from their saving efforts, particularly if it meant denying them luxuries when they were young. But most people’s primary aim is to provide themselves with protection in later life so they do not have to become a burden.
It seems peculiar that the age 75 rule, where people have to buy an annuity by age 75 or enter alternatively secured pensions, has not been updated, like state pension ages or the minimum pension benefit age have over recent years. The Government argues that few people buy an annuity between 70 and 75 but that is probably because of this restriction and the need to predict future interest rates.
It is right to reopen the debate on retirement income, especially as the market is set to expand over the next few years with the growth in defined contribution plans, but the emphasis should be on adding flexibility to the annuity rules and aligning them with the realities of life. If the Government can change the rules, annuity providers will design the right products. Maybe together we can make the options on how to take a retirement income more relevant.
Rachel Vahey is head of pension development for Aegon