Making the right decision when it comes to choosing your annuity is vital, because if you fail to make the right moves before retirement, you could end up having to watch every penny in later life
New rules about to come into force will give retiring workers a better chance of getting a decent deal for their pension savings – but many will still be shortchanged by unscrupulous insurers, experts warn.
A new code of conduct taking effect on 1 March is designed to make insurers do more to help consumers find the best annuity for their pension pot.
In a move necessitated by the continued low level of shopping around for annuities – with which pension savings are converted into a regular retirement income – insurers will be forced for the first time to publish their annuity rates.
“This is a watershed moment for investors; from 1 March we can expect to see more and more people getting better value and more suitable annuities from their retirement pots,” said Tom McPhail, head of pensions research at Hargreaves Lansdown.
Currently, more than half of retirees take their annuity from their pension provider, often (but not always) because in failing to shop around they didn’t take advantage of better deals elsewhere.
Comparison of different annuities is currently made difficult by the insistence of some insurers on keeping the rates they offer a secret.
With an estimated 20 per cent difference between the best and worst annuity rate, settling for a poor deal costs retirees dear. The vast majority of people buy their annuity from their existing pension provider, often unaware they can shop around for the best offer they can get, using the open market option (OMO).
While a handful of insurers are competitive on annuity rates – such as Prudential, Canada Life and Legal & General – some of the UK’s biggest insurers are anything but. Their size and failure to compete means that millions of people have settled for an inferior retirement income – and with annuities usually a one-off purchase, they pay the price throughout retirement.
A worker retiring with a pension pot of £50,000 and buying a standard annuity could get almost £8,000 more income in a 20-year retirement if they shop around.
After years of pressure from consumer groups and financial services media the regulator last month ran out of patience with providers, launching an investigation into the pricing of annuities.
Insurers responded to the threat of a crackdown by pointing to the new code of conduct.
But John Mortimer, director at Shepherd & Wedderburn Financial in Edinburgh, said they’d already had more than a decade to improve matters.
“Providers have had to mention the fact that customers can shop around through the OMO since 2002. However, the amount of information a policyholder receives can sometimes be overwhelming,” he said.
“I wish the ABI had gone further and recommended a simple fact sheet which every provider would issue showing the retirement figures and it would be in the same format from each one.”
Under the revised rules, insurers will also have to quiz savers about their health before selling them an annuity. The idea is to give more savers the chance to secure an enhanced annuity, which pays out up to 40 per cent more income to those with health conditions or lifestyles that impair their life expectancy.
Just 2 per cent of people who stay with the same provider take an enhanced annuity, compared with 60 per cent who shop around using a financial adviser, industry figures show.
The changes have been largely welcomed, though many feel more is needed to make all insurers treat customers fairly at retirement.
Graeme Mitchell, owner of Galashiels-based Lowland Financial, said: “I suspect this will not go far enough, but anything that helps the public realise they have an absolute right to change pension companies if there is something better available has to be an improvement.”
Everyone should shop around for an annuity, Mitchell added, unless their pension amounts to around £10,000 or less, in which case the options will be limited. In such instances it may be better to have it paid as a lump sum, if possible.
But the code of conduct still gives insurers ample wiggle room, he added.
“Much depends on the way the information is set out. It’s amazing how getting someone outside the industry to look at the explanation may improve what the industry thinks is a clear piece of communication but is in reality full of jargon and complex options.”
A Phoenix Life retirement options letter received recently by a Smart Money reader is just one example of Mitchell’s point. It includes the required OMO form, to be completed by the new provider in the event of the policyholder exercising their right to shop around, but without any explanation of what it is.
The Phoenix pack, like most sent out by insurers, also includes an application form for the firm’s own annuity. From 1 March such applications forms will be removed from retirement packs, to prevent savers from opting immediately for their existing provider’s product.
Yet there is a long way to go, said Mortimer, pointing to the fact that the new code won’t apply to a large number of workplace pension schemes.
“There are 2.5 million individuals who retire from work-based defined contribution schemes that are administered by trustees rather than contract-based group plans run by an insurance company who will not be covered by this new change,” he explained.
So while the new rules will be a big step forward, more is needed, McPhail concluded.
“Ultimately, we want a system where every pension investor is able to shop around for the best possible retirement income solution, with access to the right information and advice and to do so without any unnecessary delays or costs,” he said.