Compulsory annuities out with a whimper

The Pensions Bill, which recently scraped through Parliament, focused the public’s attention once again on the thorny issue of the compulsory purchase of annuities.

An annuity is a guaranteed income for life paid to you by an insurance company in return for a lump sum.

As any MP will tell you, they receive sack loads of complaints from constituents about the compulsory annuity purchase rule which applies at age 75.

Attempt to scrap compulsory annuities lost
Despite a valiant attempt by the House of Lords to scrap compulsory annuities, a last ditch vote to raise from 75 to 80, the age by which people are required to turn their pension fund into an annuity was lost.

Despite this defeat, the noble Lords have vowed to carry on the fight, with the Lib Dem spokesman, Lord Oakeshott, describing the Government’s stand on annuities as "based on a combination of arrogance and ignorance."

The Government has always been vehemently against scrapping compulsory annuities, through a mix of fear of ‘tax leakage’ and that people will outlive their assets and fall back on state benefits.

Annuities are taxed at source, whereas those doing income draw down (leaving their fund invested instead of buying an annuity) are taxed only when they take income.

The Treasury also fears that individuals will escape some inheritance tax as you can leave your pension fund to dependants if you die before age 75, albeit with a 35% tax charge. This compares favourably to the 40% inheritance tax charge which would otherwise be payable.

But the whole row over compulsory annuity purchase is slightly academic, as come 6 April 2006, it will be possible for individuals to continue doing income draw down after age 75.

Compulsory annuities effectively abolished by 2006
Under the ’pension simplifcation’ rules, which will come into force on that date, compulsory annuity purchase will effectively be abolished. After age 75, it will be possible to do a restricted form of income draw down, called an "Alternatively Secured Pension" or ASP.

Current income draw down rules allow you to take a maximum income of 100% of what a level paying annuity would pay at your current age, with a minimum income limit of 35% of that amount up to age 75, when annuity purchase is compulsory.

From 6 April 2006, you will be allowed to continue doing draw down, but with your maximum income restricted to 70% of what a single, level paying annuity would pay a 75 year old.

However, anyone reaching age 75 before 6 April 2006 will be stuck with the current rules, so perhaps the noble Lords were fighting on behalf of these individuals.

Ups and downs of the Pension Protection Fund
Elsewhere in the Bill, there was much about the Pension Protection Fund (PPF), due to come into force in April 2005 and designed to bail out the members of final salary scheme which become insolvent after that date.
 
Company schemes which enter insolvency, but which do not actually wind up before then, will also be eligible for PPF assistance.
 
This has caused uproar in industry, as robustly financed pension schemes feel that any degree of retrospection is unfair and that they will be required to bail out weaker schemes.

The PPF, however, is good news for scheme members who will finally have a measure of reassurance that their pensions will be partially protected if their pension scheme goes belly up.

The scheme will pay 100% of the benefits payable to pensioners and up to 90% of expected benefits (subject to an upper limit of £25,000 pa) to those who have yet to retire.

Pensions gain a new Regulator
The Bill also provides for the establishment of a new Pensions Regulator which will have extensive powers to check that companies fund their schemes adequately and will oversee merger and acquisition activity to ensure that it does not damage employees’ pension benefits.

Another important feature of the Bill is that schemes will be obliged to have 50% ‘member nominated trustees’ and all trustees will be required to have a better knowledge and understanding of investment and trust law.

Employers will be required to consult scheme members before making significant changes to future pension arrangements, while employees will be entitled to demand ongoing employer-sponsored pension provision, if their employment is transferred to another employer.

Index linked to 2.5%
Final salary scheme pensions will be indexed linked at 2.5%, rather than the current 5%. Although a reduction in benefits, it was considered pragmatic to do so because of the exorbitant cost of providing index linked pensions.

With the detail of the Pensions Bill yet to be made known, it remains to be seen how it will work in practice. What is clear is that, given the political importance of pensions in the run-up to a general election next year, it is likely to be one of the most influential pensions Bills ever.