The government puts flesh on its Budget commitment.
There wasn't, it's fair to say, very much good news for investors in the Emergency Budget announced on 22 June. But that isn't to say that there wasn't any good news.
Pension savers and campaigners alike have long argued that the rules that oblige pension savers to take out a compulsory annuity by age 75 at the latest are unfair, and should be scrapped.
And true to its word, the Conservative party -- as part of the ruling coalition -- announced in the budget that this is what it was doing. Accordingly, the age limit was lifted to 77, to give anyone approaching 75 breathing space to allow the new rules to come in.
And now, the Treasury has issued a consultation document, giving us an insight into its thinking about what will replace compulsory annuities. And fascinating reading it makes.
Pensions today
But first, let's look at what was wrong with compulsory annuitisation.
An annuity, at its simplest, is a fixed income for life, purchased in exchange for a lump sum of money -- your pension savings, in other words.
Rates vary -- every insurance and investment company offering annuities uses slightly different life expectancy tables -- but a typical 65-year old male will get £6,500 for life in exchange for every £100,000 of pension savings.
If that male wants to retire earlier than 65, or have some or all of his income-for-life protected from inflation, or have annuity payments continuing to be made to his spouse or civil partner after death, then every £100,000 of pension savings will buy rather less than £6,500.
For females, the equivalent figure is £6,000 -- lower, because women on average live longer.
And although guaranteed minimum periods of payment apply -- of five and ten years, for example -- the basic idea behind an annuity is that it's an income for life. Die, and the annuity provider gets to keep what's left of your pension pot.
Why change?
Fundamentally, objections to the notion of compulsory annuities revolve around three central themes.
- Having saved all their life, many people like to be able to pass on what's left of their savings to their heirs, upon death. Annuities don't let you do that. Die, and it's gone.
- Annuity rates aren't all that good a deal. Many investors in high-income shares, for example, would hope to get a dividend stream approaching annuity levels -- with there being no loss of capital to pass on to any heirs when that investor died.
- People don't like being locked into the idea of being forced to buy an annuity at a time when the stock market is down. At a FTSE 100 level of 6,700 (the FTSE in June 2007), an equity-based pension pot will have a very different value from one based on a FTSE 100 level of 3,512 (the FTSE in March 2009).
So what is the government proposing?
Tax treatment
First, it's gone to considerable lengths to spell out how the taxation treatment of pensions will work in an era of no compulsory annuitisation. The basic idea is that pensions are there to provide a retirement income, not provide a tax-free way of passing on savings to heirs.
So pension income will continue to be taxed, in other words, and any funds passed on to a saver's heirs will also be taxed, in order to claw back the benefit of the original tax relief -- although inheritance tax won't then be applied as well. Whew!
The existing 25% 'lump sum' rules will continue to apply, as will tax-free death benefits for those who die before age 75 without having accessed their pension savings.
Further rule changes to contribution limits, lifetime allowances and age-related tax relief are to follow, but the guiding principle from an investor's point of view is clear.
"The Government does not intend pensions to become a vehicle for the accumulation of capital sums for the purposes of inheritance... It will therefore ensure that the tax rate on unused funds remaining on death does not leave open incentives for pension saving to be used to reduce inheritance tax liabilities."
Accessing your funds
If there's no obligation to buy an annuity, then what will govern how an individual can access the funds tied up in their pension pot?
Again, although the exact rules have yet to be formalised, the basic framework is now clear.
First, as with the present drawdown rules, a cap will be in place determining how much of a saver's pension pot can be taken as income in any one year. The basic idea: to stop people consuming so much of their pot that it runs out before they die, forcing them to rely on state provision.
At present, the annual drawdown cap is set at 120% of an equivalent annuity, using calculations based on figures and assumptions published by the Government Actuary's Department.
Something similar will apply in future, with the complex pre-75, post-75 distinction between unsecured pension arrangements (pre-75) and alternatively secured pensions (post-75) being scrapped.
Again, the critical words in the paper are these:
"Individuals will be able to choose how much to draw down annually from their pension pot throughout their retirement (subject to a capped limit), or whether to draw any income at all."
But suppose you want to drawdown more than the capped limit? Before, you couldn't -- now, it's proposed, you will be able to.
How so? By pensioners demonstrating that they have secured a sufficient minimum income to prevent them from exhausting their savings prematurely, and so falling back on the state.
The minimum income requirement
Hence the introduction of something called the 'Minimum Income Requirement' -- basically a secure income, guaranteed for life, that takes into account reasonable expectations of the future cost of living.
If you meet this minimum level -- before your pension fund is taken into account -- then you'll be able to drawdown your pot at whatever rate you like. The logic? It doesn't matter if you exhaust your pension pot, because you already have an adequate level of income provision to fall back on.
It's around this Minimum Income Requirement, of course, that I suspect most of the consultation process will revolve, and the government itself has articulated in the paper a number of questions that must be resolved.
Logically enough, the state pension counts toward the Minimum Income Requirement, but what other forms of income are considered acceptable. And what does 'secure' mean, exactly? How is inflation-proofing to be handled? What level should the Minimum Income Requirement be set at, in cold hard pounds and pence? Should it vary with age -- and if so, in what direction? And so on.
Got an opinion? Let us know in the box below. But don't forget to tell the government, either. The consultation period ends on 10 September, and responses should be sent by e‑mail to age75@hmtreasury.gsi.gov.uk or by post. Public meetings are also planned -- the e-mail address above will provide details.
More from Malcolm Wheatley:
> In February, The Fool Community lost Fancyfree50, a regular poster on pension issues, who helped countless fellow Fools with their pension problems. RIP, Fancyfree50.
