Annuities are not dead and buried

Indeed, ditching the annuity for something far less secure could well be a catastrophic mistake, and while it may provide a lip-smacking new market for financial services providers, the consequences of getting it wrong are truly dire.

For one thing, killing off annuities completely could throw into question the unwritten ‘pensions covenant’ that is a guiding principle of UK pensions regulation. This covenant says, in essence, that the government will provide major tax incentives to invest in a pension in return for pension holders saving wisely to avoid becoming a burden on the state in later life. In other words, the state says if you forgo a bit of “jam today” we will make sure you get “jam tomorrow, plus a bit on top.” A fair deal, many would say.

Another concern is that the Treasury will begin to see pensions as little more than a long-term savings scheme, no better than a fancy Isa. The Treasury might begin to question the generous tax reliefs given to pensions, particularly the 25 per cent lump sum and the higher rate relief, if pensions are just another tax shelter.

Unlike many, I do not see the annuity changes chancellor George Osborne unveiled in his Budget as anywhere near as radical or as generous as many critics have made out. In truth, successive chancellors and governments have been chipping away at the obligation to buy an annuity for many years. Mr Osborne just finished the job off.

The irony is that, while annuities have been portrayed rightly as inflexible and increasingly poor value due to sliding annuity rates, for all their faults, they are a fundamentally sound principle: a guaranteed income for life to see you through your non-earning years. Anyone see anything wrong with that?

Scrapping annuities for income drawdown or other, more complex options, may be long-awaited flexibility for some, and I welcome that, but it also increases the risks, and do we really want that at retirement?

My biggest concern is about the headlong rush to ditch annuities without considering the consequences. In the US, where there is no obligation to buy an immediate annuity, the immediate individual annuity market has crumbled to just 3.6 per cent of total annuity sales. In many ways, we are simply following this market.

That may be fine for Americans used to taking a more active role in their savings and portfolios through their 401k pension plans, but in the UK the general public lacks investment skills or perhaps the appetite to invest. HMRC figures show that there were around 14.6m adult Isa accounts subscribed to in 2012/13, but 80 per cent of subscriptions were to cash-only Isas. Does this suggest that British consumers are ready for all the investment challenges of income drawdown? I do not think so.

It will be quite easy for many consumers to be tempted into taking too big an investment risk in return for taking a little more ‘jam today’ from their income drawdown plan, and hoping things will turn out all right in the end.

More likely we will see large numbers of UK consumers swapping their pension pot for an income drawdown plan in their early sixties, only to run out of money in their mid to late seventies. What then? Who will look after them? The answer is the state, of course. Given the average size of DC and personal pensions in the UK, this is a serious prospect.

So what happens when all this freedom arrives next April? While I doubt many will rush out and buy a Porsche or gamble their pension away, it could be overwhelmingly tempting for many to ‘turbo boost’ their pensions in the early retirement years, taking out plenty of income, only for the fuel to run out of their pensions vehicle in later years as it runs out of cash.

All of this is a doom-laden scenario, I know, and I do think it more likely that public demand and creative energies in the financial services sector will provide a more sensible approach to income withdrawal, and perhaps a later-life income guarantee. A hybrid annuity-income drawdown plan, if you like, which provides a decent income early on, but avoids the money running out completely by providing a safety net of some kind later on.

Pensions flexibility is a good thing and allows more people to have more choices at retirement, but I have a niggling feeling that killing off the annuity, or the principles behind it, will come back to haunt us in future years.

Kevin O’Donnell is a financial writer and journalist

I have a niggling feeling that killing off the annuity, will come back to haunt us in future years.