This piece first appeared in Saga Investor in Autumn 2001
The text here may not be identical to the published text

Set my pension free

Retirement looms and you finally get round to looking at those statements from the insurance company. It looks good. You are expected to have around £100,000 in your pension pot – saved up through various pension schemes over the last twenty years. It sounds a lot of money. What will you do with your pot of gold? Buy a property and rent it out? Pit your wits against the professionals in the stock market? Invest it in safe unit trusts and perhaps spend a bit of the capital as you need it? Forget it. The Government will tell you how to invest your money. And it will force you to pick an inflexible product with a poor return.

Welcome to the world of annuities. Fifteen years ago, when Margaret Thatcher launched the pension revolution, annuities were seen as safe and good value. But today we will get barely half the amount the insurance companies would have paid then. They work like this. In exchange for our pot of gold, the insurer gives us an annual income, guaranteed for life. If we live much longer than average we get more than our money back. If we live an average time or less, the insurance company wins. So it is a gamble – after all, insurers are just bookmakers in sober suits. But it is a bet the insurance companies have been losing. First, they failed to predict the longer life people can now expect – roughly another 20 years at 65, four years longer than in 1980. Second, they failed to predict how much interest rates would fall – now at their lowest for a generation.

The result is that the pension you get today from even a large pot of gold is poor. A man with £100,000 (and that is much bigger than the average pension pot) who buys an annuity today at age 65 will get at most just over £9000 a year for life. If he takes the wise precaution of choosing an annuity which will rise each year with inflation he will get much less – barely £6500 a year. And that is from the best annuity provider. The worst – and very few people check out the market to pick the best – will pay at least £1000 less. Women, who live around four years longer than men, get around ten per cent knocked off those amounts.

The result is that £100,000 saved up for your retirement will only convert into an inflation-proofed, taxable income of around a third of average earnings.

Even though annuities are such bad value, the Government forces us to buy them. When we retire with our pension fund - which can be at any time from 50 to 75 – we can take a quarter of the total and do what we like with it. But the balance must be used to buy an annuity. We can defer that decision and take an annual income directly out of the pension fund. But the amount of income cannot be more than roughly what we would get from a good annuity. When we reach 75, the remainder of the fund has to be used to buy an annuity. We are trapped.

The Government says it is reasonable to control what we do with our own pension savings. If there were no controls we might spend the lot in a few years on a wealthy life-style. Or we might invest it foolishly and end up poverty stricken. Either way, we would ask the state for help with our depleted income. We were allowed to save up for our pension free of all tax, so why should the state pay again to keep us out of poverty? It’s a fair point. But there is a simple answer.

The Government sets a level of income below which it will never let any pensioner fall. It is called the minimum income guarantee and is currently £92.15 a week for a single person, nearly £20 a week above the level of the state retirement pension. Anyone with an income less than that can go to the state to top up their income to that level.

So all the Government need do is to make it compulsory to buy an annuity to bridge the gap between the individual’s state pension and the minimum income guarantee. That way they can never come to the state for help.

The gap between the basic state pension and the retirement pension will grow year by year because the basic pension rises each year in line with prices, whereas the minimum income guarantee rises in line with earnings which grow much faster. But the insurance industry could easily devise a product to pay an income each year to bridge that growing gap. And once we had bought an annuity to cover it, then surely our obligation to the state should be over? We could do what we want with the rest – spend it, invest it, save it, waste it. It is our money after all.

Sadly, the Government has boxed itself into a political corner. At the General Election both the Conservatives and the Liberal Democrats promised annuity reform. So Labour said none was needed. It was wrong. And the sooner it admits it the better. We’ve saved our pot of gold – now we want the rainbow.

Autumn 2001


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