The new Lib-Con government has already announced one bit of good news. The rule that forces us all to buy an annuity when we turn 75 is going to be scrapped.
An annuity is an income stream for life bought with your pension savings (assuming you’re not part of a defined benefit, or final salary scheme) when you retire. But, sensible as that sounds – after all we need an income when we stop work and £95.25 a week in state pension is hardly a fortune – annuities are flawed. Rates are low, so the income generated per £100,000 of savings can be paltry. And if you die after, say, a couple of years of retirement, your family won’t get the benefit of your years of hard saving – in most cases the annuity dies with you.
The other big drawback with annuities, that affects everyone regardless of the size of their pension pot, is inflation. Most annuities aren’t inflation-linked, you have to pay extra for one that is, so your fixed income’s purchasing power decreases over the years as inflation rises. Over, say, 20 years, even relatively low inflation can make a dent in your standard of living.
But annuities aren’t all bad. If you have a relatively small pension pot they are a good way to guarantee you have a predetermined income for the rest of your life. If you shop around for the best rate, rather than taking the one offered by your insurer, you can boost the amount of income you receive.
An alternative to an annuity is income drawdown, often used between retirement, at, say, 65 and turning 75. Your pension remains invested but you draw an income from it. But there are risks here too – your pension pot is still invested and so could be hit by a fall in the stockmarket before you buy an annuity. However, if you die the pot can at least be passed on to your heirs – albeit after the government takes a 35% cut.
Once you reach 75 you still have to choose either an annuity or an alternatively secured pension (ASP). An ASP means that you can continue to invest your pension savings while drawing an income. The problem with ASPs is that they are complicated, your lump sum may drop in value if markets plunge, and while an ASP does allow you to pass your money on, it is subject to tax upon your death at a rate of up to 82%.
Removing the 75th birthday rule would give us all more control over our pensions and leave us less exposed to the vagaries of annuity rates. But until the government clarifies what will replace the current rule, anyone who can afford to defer buying an annuity should do so.