Like most major gambling centres, Pension City UK is highly regulated and companies must play by the rules. When a new development is proposed, an immediate question is, is it legal? Companies stretch the rules to the limit to offer flexibility to clients and, if a particular game is not allowed under the rules, they lobby for a change in the law.
The authorities in Pension City are particularly concerned to ensure their tax incomes not reduced by any changes in the rules. Com panies and their clients are expert at exploiting tax loopholes so the authorities tend to treat new proposals with some suspicion.
A key current question is, what is an annuity? The answer used to be obvious – an annuity provided a guaranteed income for the rest of your life. Investment-linked annuities muddied the waters because the amount of your income was no longer guaranteed but buying an annuity remained a one-off decision when you retired. However, developments over the last year or so have confused the issue.
Some annuities can now be changed after they are bought. For example, investment-linked annuities may have an option to convert to a conventional annuity or to change the anticipated growth rate.
More radically, one product involves buying a series of five-year temporary annuities while keeping the bulk of your pension fund inv ested. The income can be changed at the end of each year period, within limits. This process can continue up to the age of 85, not 75 as is currently the case with income drawdown.
So, what is an annuity? The Inland Revenue has promised guidance on this but currently appears to e
xpect two essential features.
First, an annuity is an irrevocable contract between the individual and the insurance company – there is no option to move company. So, even if the annuity can be changed, this is on terms offered by the provider with no open market option facility. Second, an annuity involves a cross-subsidy from those who die early to those who live for a long time. When you die, your fund is not returned (even with the product where the fund is still invested).
The pensions of those who enjoy a long retirement are effectively boosted because insurers can estimate what they will gain from the early deaths. In some cases, including many with-profits annuities, the pensions of survivors are dir ectly affected by the mortality experience.
We will certainly see more innovation in the market, especially when the Revenue gives firmer guidance. There are also developments in phased retirement and income drawdown. From next April, it will be possible to take benefits from an individual personal pension arrangement in stages. At present, whole arrangements must be encashed at once and phasing is achieved by dividing plans into multiple arrangements (typically. 1,000).
This makes them more complicated and any encashment must be the value of a whole number of arrangements instead of just the amount specified by the investor. This changes next April for, among others, existing per sonal pensions although not for the older retirement annuities or for executive plans.
Drawdown regulations allow triennial reviews of several drawdown plans to be done at the same time. Previously, an individual with several plans with the same provider (most likely through a combined phased/ drawdown arrangement) had a different review date for each which involved extra work for everyone.
Now, provided that the scheme rules allow it, the reviews may be combined, with the triennial review dates of the first plan bought being used for all of them. An additional concession allows triennial reviews to be done up to 60 days before the actual anniversary. Taken together, these changes make drawdown, and phased drawdown in particular, more straightforward for provider, adviser and client.
Another drawdown issue will be resolved soon. Until now, you could not transfer to a different scheme during drawdown, even if your provider's investment performance was poor (there was, though, an open market option when you bought your annuity). Self-investment options were a partial solution but, from the client's viewpoint, it is better if the whole plan can be transferred. The new personal pension transfer regulations are due imminently and will allow this facility.
Finally, there is the old chestnut of possible changes to the age 75 limit for buying an ann uity. Why should people not be allowed to continue drawdown, at least for a few years longer, instead of handing over their whole fund to an insurance company?
The Government's concern about this is over a delay in tax revenue if individuals choose low income levels or an increase to means-tested benefits if high income is taken and funds run out. It does not want changes to affect its cashflow adversely.
For the individual, too, a change could cause problems. If annuity purchase is delayed until, say, 80, mortality drag becomes very significant. A 79-year-old single male would need a return of about 13 per cent to justify continuing drawdown for another year.
The longer that drawdown continues the more likely it is the client will become incapable of making decisions on income and investments. An enduring power of attorney, allowing someone else to make decisions on behalf of the individual, helps with this problem but is poten tially messy and time-consuming.
A compromise solution is possible. The Government could insist on a certain amount of guaranteed income from index-linked annuities but beyond that allow individuals considerable flex ibility in using their retirement fund.
The Government Actuary's Department's limits for income drawdown would need to be reviewed but this does seem a practical solution. It was proposed by Dr Oonagh McDonald's retirement income working party and might well find favour with the Government.