Dash to smash the pension pot piggybank backfires

Once its gone, its gone: Cashing in pension pots is already distorting annuities. Picture: Comstock

Leading annuity providers Just Retirement and Partnership Assurance have joined forces after being hit hard by the so-called pension “freedoms” that took effect this year. Both saw their share prices plunge when the reforms were set out in the 2014 Budget and with annuity sales falling sharply since then they have struggled to recover.

Advisers warned that the income paid by annuities could fall further as a result of the £668 million deal, with a particular impact on enhanced annuities (available to people in ill health or with certain lifestyle characteristics).

The reforms in April allow savers aged 55 or over to take their entire pension pot as a lump sum, including 25 per cent tax-free. The remainder is now taxed at the saver’s marginal rate, rather than the current 55 per cent charge.

Sales of individual annuities have duly plummeted, falling 42 per cent from £11.9 billion in 2013 to just £6.9bn last year.

Whereas most people previously used their pot to buy an annuity, those able to take advantage of the new rules are either withdrawing some or all of their cash or entering flexible drawdown, where they can leave their pension invested and take income from it as and when they need it.

Yet for many people annuities remain the most suitable option for converting pension savings into a retirement income. Surveys regularly show that a guaranteed income – which annuities provide – is the top of most people’s financial wish-list in retirement.

The Financial Conduct Authority (FCA) has said that annuities usually offer better value for risk-averse savers with average-sized pensions, as long they are bought on the open market. Many savers settle for lower incomes by taking their annuity from their existing pension provider, however, a situation that continues to be the focus of regulatory scrutiny.

Eight in ten of those that take the rate offered by their existing provider could get a better deal if they shopped around on the open market, according to the FCA.

The income paid by annuities has actually improved in recent months, according to new data from IRESS. It said the average rate for a single life annuity reached 5.09 per cent in June, a six-month high and compared with 4.86 per cent in March. The increase was due to a combination of improving economic figures and an increase in gilt yields, which are used in the pricing of annuities.

IRESS also revealed the gap has further widened between the best and worst rates on enhanced annuities (which pay out significantly more income to those with medical conditions or certain lifestyle characteristics, such as smoking), underlining the importance of shopping around before tying into a deal.

For people who qualify for enhanced annuities – and the many people for whom drawdown is unsuitable and who will use at least some of their pension to buy a normal annuity – the merger announced this week could be a further blow, accelerating the long-term decline in payouts.

The deal should bring more stability to the market, according to Graeme Mitchell, managing director of Lowland Financial in Galashiels. However the reduced choice will mean anyone wanting to buy an annuity will probably be worse off, he added.

“These two were generally at the top of enhanced annuity tables and we would often be able to play one off against the other to get better rates; with the merger they may not feel the need to be as competitive,” said Mitchell.

Richard Eagling, head of pensions and investments at Moneyfacts, agreed.

While the new, larger group could become “an annuity powerhouse” that brings new innovation and products to the market, there will be a negative short-term effect on consumers.

“The big concern is the potential impact that this merger may have on enhanced annuity rates and the subsequent retirement incomes available to consumers, as the competition between these two providers has been instrumental in sustaining higher annuity rates in recent years,” said Eagling.