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Better annuities a step closer as new rules aim to improve retirement

Under a proposed new code of conduct the insurance industry will be compelled to give better information on annuities, leading to the highest possible retirement income

The pensions market is facing a shake-up that will improve the way annuities are sold and could drastically improve retirement incomes for more than two-thirds of pensioners.

The Association of British Insurers is believed to be on the verge of approving a new mandatory code of conduct for pension companies that sell pension income – also known as annuities – ensuring people will get the highest possible income in return for their pension pot.

The draft code requires pension providers to ask their policyholders a series of questions to work out the best type of annuity for them. This should identify whether they might be entitled to an enhanced annuity on the grounds of poor health, and the pension company will be required to alert the customer if it doesn’t sell this type of product.

Someone in good health who opted for the lowest annuity rate quoted on the open market would get 12% less income in retirement than had they bought the “best buy”, according to the National Association of Pension Funds. To make up for this loss, people would have to retire two years later.

The difference is even greater if the person retiring suffers from ill health. Stephen Lowe, a director of Just Retirement, a specialist annuity provider, says a customer’s pension income can even double, depending on the severity of their health problems, “although the typical uplift is 20% to 25%”.

Just Retirement has been carrying out a trial through independent financial advisers (IFAs) to determine whether people would qualify for an enhanced annuity. “Currently 12% of all people buying annuities get an enhanced one. Of the 66% who buy an annuity from their existing pension provider, just 1% end up with an enhanced annuity. But our trial indicates that up to 70% could actually benefit from a higher pension income because of their health,” says Lowe.

There have been calls for the new code to require all annuity providers to publish their annuity rates, showing the amount of income a person will get in return for their pension savings. Although companies which sell annuities on the open market are required to publish their rates, those which sell annuities only to their own pension customers are not. This means that companies, including well-known providers such as Scottish Widows and Friends Life, have been able to hide the low incomes they provide compared with other companies.

The Pension Income Choice Association (Pica), a group representing product providers, IFAs and employee benefit consultants, commissioned Oxford Economics to research the impact of shopping around for retirement income two years ago. It found that if everyone exercised their “open market option” to shop for the highest paying annuity or alternative product, they would collectively benefit from between £3bn and £7bn extra pension income.

Because pension incomes are taxable, and pensioners would have more to spend – generating indirect taxation – and the number of people on social security would be lower, the Exchequer would benefit by between £1.7bn and £3bn.

On its website, Pica says that the customers most likely to exercise their right to shop around for the best annuity rate are the affluent, who have large pension funds. Those who benefit from any improvement to the way annuities are sold are likely to be people with small pension funds – who will gain most from an increase in their retirement income.

Requirements for insurance companies to support their solvency by owning a large proportion of gilts and bonds, and the Bank of England’s rounds of quantitative easing, have both had a negative effect on annuity rates, and there seems to be little prospect of these improving in the short to medium term.

Pica says: “Britain stands on the edge of a national tragedy. Future generations of pensioners will be significantly poorer than previous generations. The current system is failing the less well-off members of our society who most need to maximise their pension savings if they are to avoid hardship in retirement. The potential gain from a review of retirement options has never been greater.”

Lowe is more blunt: “The ABI has promised improvements in the shopping-around process for many years, but little has changed. This new code is probably the ABI’s last chance to get their house in order or else the government will have to step in and change the law to force them.”

Even with these changes many people will still end up with less retirement income than they could, says Tom McPhail, pensions expert with independent financial adviser Hargreaves Lansdown. “[The code] won’t fix the whole problem because more could still be done to encourage people to shop around. Those who choose not to will still not be certain of getting a good deal from their pension company.”

How to improve your pension:

The Class of 2012, a survey of nearly 10,000 adults over the age of 45 for the insurer Prudential, has found that 45% thought they would not have enough money to live on in retirement: one in five expects to retire on less than £10,000 a year, including the basic state pension, while 6% say they will retire on just £5,000. The average expected retirement income is £15,500, 16% less than in 2008 when retirees expected to live on £18,600.

Those who suspect they face a meagre, if not impoverished, retirement may be able to improve their situation and that of their family by exploring the following options:

1. Do not simply accept the annuity offered by your pension provider – shop around for the highest rate possible. For the sake of spending an hour of so talking to an independent financial adviser you could end up with a substantially better pension income. Go to to find IFAs offering advice on annuities in your area.

2. Think about what your needs are. Do you have a partner or other dependents who would suffer if you die and your pension income ends? Are you prepared to live on the same income throughout the rest of your life or would you feel safer with an income which increases by a set amount every year or by the rate of inflation?

3. Be honest about your health. It is very British to be restrained when talking about illness, but when you are applying for an annuity you should give as much information as possible. Put brutally, the shorter your life is likely to be, the higher the income you will receive.

4. How do you feel about your family loosing all your pension if you have bought an annuity and die young? Tom McPhail of IFAs Hargreaves Lansdown says those with big pension funds can opt for income drawdown, which allows you to keep your money invested in a pension while withdrawing cash within certain limits. Money left over when you die will pass to your beneficiaries as a lump sum subject to 55% tax (or your spouse can simply draw an income subject to normal income tax).

People who prefer to buy an annuity could opt for a “value protected annuity”: in return for an extra cost, typically 5% of the income, the policyholder can arrange for any residual money left over when they die to be paid to their beneficiaries.

5. If you are still quite young when you retire, you are likely to get a low pension income if you are in good health. If you intend to carry on working part time, you could either leave all or part of your pension invested to carry on growing. Alternatively, you could put your pension into a fixed-term annuity which pays out a set income for a set number of years and returns the remainder of your pension to you at the end, so you can buy a regular annuity. © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds