The troops have stormed the castle, the revolution is approaching its climax and the campaign to abolish the compulsion to buy annuities senses victory.
But before we do away with the present system, it would be sensible to have something to replace it. Nobody has yet put forward a credible alternative. There are only two ways to pay out income from a pension fund. One is an annuity, the other is drawdown. If annuities are out of favour, is drawdown in favour?
One week the press talk about the misery of annuities, the next week they will talk up concerns about a scandal over drawdown. Surely it is time to have some joined-up thinking?
Why is there almost complete silence from the pension industry and little support for annuities? There is a small group of us who constantly put forward good arguments as to why annuities are good value but these receive a very small proportion of the column inches devoted to this important matter.
Recently, I wrote in support of annuities only to receive the response: “Poor Mr Burrows, he would say that, wouldn't he?” Why do I defend annuities? My son would say it is because I am a sad person. I say it is because of the many clients who have said to me: “You know, that annuity was one of the best investments I ever made.” These were sophisticated clients who had often owned both annuities and drawdown plans, so they knew what they were talking about.
Not only are people more confused than ever, they are losing confidence in pensions and, most worrying, may end up making the wrong decisions. Do not get me wrong, I am not trying to defend the indefensible. I believe it is time to call for the end of compulsion, not because annuities are poor value for money – they provide very good value – but because the social and economic situation has changed considerably since compulsion was first introduced.
If people want more choice, let them have it, but freedom is not licence. Along with greater freedom comes a greater responsibility.
The Inland Revenue argues that tax relief on pension contributions is given to provide pension income in retirement and still relies on historic definitions of annuities such as in the legal case of Foley v Fletcher (1858): “An income is purchased the capital is gone the principle having been converted into an annuity.”
Therefore, it is not in favour of schemes which allow members to take their entire funds as a lump sum or to pass the capital to their dependants. Although the Revenue has bent over backwards recently to allow for a more liberal definition of an annuity, it is constrained by the existing legislation.
I believe there is a very simple solution. My proposal is that pensioners should be allowed to continue with a form of pension drawdown after age 75 subject to two rules. The first is that, at age 75, there should be a requirement to purchase a minimum level of annuity to ensure that people have sufficient income so as not to be a burden to their family or the state. The amount of annuity is open to debate but should be set at a level which does not unduly disadvantage those with smaller funds or limit their options.
The second rule is most important. Pensioners should only be allowed to continue making income withdrawals if they are subject to rules which regulate how much income should be taken. I have in mind limits which are similar to the minimum distribution rules that apply to 401(k)s in the US. There is a simple formula for calculating this minimum distribution. Every year, the amount remaining in the pension fund is divided by the life expectancy and, because each year life expectancy decreases by less than one year, the policyholder will not run out of income.
The Revenue should be happy because people are using their pensions to provide income and paying their tax, pensioners should be happy because they have more control and flexibility and politicians should be happy because everybody else is happy.
There are drawbacks to this approach. What happens if the fund does not grow as expected and what happens if people live longer than expected? Surely the point is that, if people want more choice, they must be prepared to take more risk? In any case, they will already have invested part of their pension in an annuity.
I would argue that many people will still be well advised to purchase an annuity well in excess of any compulsory minimum and many may wish to combine annuities and systematic withdrawals to achieve a tailor-made package.