Millions face pensions chaos

7th February 2012

The study says that annuities, the mechanism that converts a pension pot lump sum into an income for life on retirement, cost holders who cash in plans up to £1bn each year compared with "best buys".  And the loss will worsen as more post-war baby boomers quit work. Longer term the "deficit" could treble to £3bn over the next decade as up to eight million more go into money purchase pension plans via the "auto-enrolment" which starts later this year (at the biggest employers and working down into smaller firms).

The economy suffers as well from a flawed annuity system – the report estimates around 20% of these losses (or failures to gain) are passed on to the public in the form of lost taxes and higher means-tested retirement benefits.

But while the report characterises annuities as "opaque" and uncovers "evidence of sharp practice and murky pricing", it largely fails to address two distinct difficulties.

Many of the arguments and proposals in the paper have been well rehearsed over the past years – in particular by IFAs eager to break into the lucrative annuities market where a £100,000 pot typically generates £1,000 to £1,500 in commission, often for little  more work than providing a comparison website.  But the need to repeat the arguments shows that little has been taken on board.

On retirement, those in money purchase plans need to turn at least 75% of their pension pot into an income for life via an "annuity", generally from an insurance company. Other than a few flexible schemes aimed at the very wealthy, these plans cannot be changed or reversed once the pension holder has signed up.

The process for choosing an annuity is complex – pension buyers have to decide when they want to take their money and whether provision should be built in for a surviving partner and/or for annual uplifts. The more "bells and whistles", the lower the starting rate will be.

Despite a number of comparison websites, usually from IFAs and paperwork urging people to shop around (exercising the open market option) – including special enhanced annuities for those in poor health or who smoke  – the majority still go for the ‘default' option by sticking with their scheme provider, a decision which can wipe 30% off their annual pension income, and in some cases up to 50%.

So why is it so hard to get a good deal – even within the confines of the present system?

The report found:

Can savers trust the annuity companies?

The report uncovered sharp practice and murky pricing in the annuity market, putting unsuspecting consumers at a huge disadvantage.  It discovered annuity prices are often heavily manipulated:

"Most of the competition is between £40,000 and £100,000. They will offer lousy rates below this as they reckon most holders of  smaller pension pots will not bother to shop around. But perversely they may also offer lower rates for very big pots as they reckon those with that sort of money are healthier (because wealthier) and will live too long," one IFA said.

Where to go now

The NAPF/PI report recommends:


More from Mindful Money:

Where next with the financial crisis? Pension Fund default?

Psychological barriers to investment – and why they are ignored

Will the mass market embrace financial advice?

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