MODERNISING ANNUITIES
A consultative document from the Inland Revenue & Department of Work and Pensions
Comments from the Association of Chartered Certified Accountants
April 2002
Executive Summary
The Association of Chartered Certified Accountants is pleased to have the opportunity to respond to the Inland Revenue/Department of Work and Pensions (DWP) consultative document 'Modernising Annuities'. ACCA is a professional body which represents 44,000 accountants in the UK. Our comments in this submission draw on the experience of senior ACCA members who offer a wide range of perspectives on retirement saving.Our overall reaction to the consultative document is disappointment that the Government has addressed the future of annuities in apparent isolation from factors and trends which are threatening to undermine the hitherto successful private sector pensions market in the UK. Foremost among current trends is the accelerating movement away from final salary occupational schemes, which is itself the result of a range of other contributory factors. The document has failed to explore any radical changes to the current rules on annuities which we suggest would have been appropriate in the light of changes in the overall pensions environment.
Given that more and more individuals, particularly those with lower earnings, are being exposed to the uncertainties associated with money purchase pensions, and given the Government's stated aim of reducing dependence on the state for retirement income, it is essential that the Government lays down foundations which not only encourage investment and saving during individuals' working lives but which also enable retired persons to make the most profitable use of their accumulated funds. The latter aim is not necessarily achieved by requiring all funds to be converted into annuities.
When developing its proposals for the pension credit, the Government implemented extensive international research and examined in detail initiatives which had been undertaken in Canada, Australia and the USA. The proposals for modernising annuities have, however, omitted to consider how practices which have proved successful in other, comparable countries, could be used as a basis for shaping policy in the UK. We believe that this may have constrained the Government's thinking on this issue.
In developing its policy on annuities, the Government lays down a number of aims. These include the aim of increasing the amounts of individuals' retirement incomes. We do not believe that exclusive concentration on annuities is conducive to the achievement of this aim.
The Government should introduce new, more flexible arrangements for the withdrawal of income from a money purchase pension fund. Rules should require the withdrawal of a minimum level of income but the remainder should continue to be held and invested in the member's fund. On death, the fund should form part of the member's estate but be subject to Inheritance Tax or an exit charge. Most importantly, there should be no compulsion on a member to convert the whole of the pension fund into an annuity. The individual's accumulated fund should also be capable of being used to meet designated expenses, for example the cost of hospital treatment.
1 General Comments
We make the following general points in relation to the central issue of compulsory annuity purchase.DEVELOPMENTS IN OCCUPATIONAL PENSION SCHEMES
1.1 The DWP's own figures show that the proportion of private sector organisations offering some form of provision has declined from 34% in 1998 to 29% in 2000 (although, admittedly, many small firms will by now have 'designated' stakeholder pension schemes). Figures published by OPRA show that, in 2001, 750 occupational schemes were either frozen or closed to new members (compared to only 44 in 2000). Many industry observers are predicting that final salary occupational schemes will virtually disappear within the next twenty years.
1.2 It seems possible that we are now seeing a historic and irreversible movement away from final salary to money purchase schemes. At the same time, there are worrying signs that employers are reducing the level of financial contributions which they make to the pensions of their staffs. This means that not only are more and more individuals having to prepare for their retirement on a money purchase basis but that the amount which many can expect to accumulate over the course of their working lives will not result in a pension which is as substantial as they might have expected or as substantial as those which were enjoyed by earlier generations.
1.3 People can only be encouraged to save if they feel that, by doing so, they will ultimately be better off than if they rely on the state for financial support. This applies especially to those on lower earnings: the sales figures to date for the stakeholder pension suggest that the Government needs to do a lot more to give people confidence that investment in money purchase pension schemes will enable them to make acceptable provision for retirement. In our view, this situation calls for an open-minded approach with regard to how to achieve this objective.
INTERNATIONAL SOLUTIONS
1.4 In considering possible solutions to current difficulties, the consultative document does not address whether the UK could learn from the experience of other, comparable countries. We consider that the failure to do so has restricted the Government's thinking and led to unsatisfactory conclusions.
1.5 We note the evidence given in the House of Commons on 11 January 2002 during the course of a debate on the Pensions Annuities (Amendment) Bill. This evidence reported that, in 1988, individuals with regulated retirement savings plans were offered the option of putting their accumulated funds into special pension accounts, as an alternative to buying compulsory purchase annuities. This reform has led to a 50% increase in the number of persons investing in retirement savings plans.
1.6 Developments in the US have been just as dramatic. Since the flexible 401k plans were introduced in 1978, such accounts have come to be held by two thirds of those who have retirement savings and some $1.8 trillion worth of assets were invested in them by the end of 2000. 401k plans have the advantage of allowing employees to choose how much they contribute, tax free, and also allow members a high degree of choice as to how their funds are invested. While 401ks are subject to comparable rules regarding tax relief on contributions and the taxation of pensions in payment, the flexibility and choice which they offer are, in our view, crucial factors in explaining their real popularity.
1.7 We believe that it would have served the interests of completeness if the consultation exercise had discussed other approaches, of countries which had already experienced similar difficulties to those which the UK is experiencing now. Not to have done so gives the impression that the UK is unwilling to learn the lessons of other countries. TAX ISSUES 1.8 At several points in the document, the authors defend the obligatory nature of the annuity on the grounds that it ensures that (i) tax concessions are awarded exclusively in relation to contributions which are intended to fund retirement income; and (ii) pensions in payment become subject to tax.
1.9 We do not dispute either that tax relief given on pension contributions should be expressly linked to savings for retirement or that, in return for relief on the contributions, tax should be payable on the pension when it actually falls to be paid. Contrary to the impression given by the document, however, this should not in itself prevent the Inland Revenue from considering alternative arrangements to those which currently exist.
1.10 The proposals originally put forward by the Pensions Retirement Working Group, and those now incorporated in the Pensions Annuities (Amendment) Bill currently before Parliament, would in fact make clear that income drawn from the member's fund would be subject to tax and that any residual fund passed on to a member's beneficiaries would also be subject to tax. 1.11 In affirming its continued commitment to the compulsory annuity requirement, the document fails, in fact, to note that the Inland Revenue has recently approved a number of schemes, launched by Canada Life, Prudential and London & Colonial, which have allowed individuals to continue to invest their accumulated funds and take income from them, with no obligation to convert them to annuities at a set age. While ability to take out one of these plans is dependent on the consumer having accumulated a substantial minimum pension fund, it appears to us that these precedents could have encouraged the authors of the document to have adopted a similarly imaginative and flexible approach to annuities generally.
1.12 In the context of the statement at paragraph 156, to the effect that the Government offers tax breaks in order to help people achieve secure retirement incomes, we feel it necessary to point out that the Government's own recent actions, in withholding tax credits in relation to dividends paid by UK companies, have severely hindered the ability of money purchase pension schemes to accumulate adequate retirement funds (and at the same time have helped to undermine employers' commitment to final salary schemes). We consider that the abolition of dividend tax credits will continue to make the task of encouraging people to save for retirement extremely difficult.
THE 75 AGE RULE
1.13 The Inland Revenue currently requires that individuals must take out an annuity by the age of 75. At paragraph 51, the document refers to the fact that life expectancy generally is increasing - it has in fact increased significantly since the current age limit was introduced in 1987. It does not go on to consider whether, given this fact, there is a case for changing the age 75 rule. This matter needs to be addressed.
2 Feedback Questions
We would like to make the following points in relation to the specific questions posed in the text and repeated in Annex 1 of the paper.CHAPTER 4 ISSUES
2.1 The text refers to the 'popularity' of flat annuities, as opposed to the index-linked variety. In our view, the term 'popularity' used in this context is misleading. That more individuals who are compelled by the rules to buy annuities choose to buy flat annuities rather than any other kind of annuity should not be taken to mean that flat annuities are 'preferred' by consumers or are considered by them to be a superior product. Flat annuities are more common because index-linked annuities are significantly more expensive and also because no prospective annuitant can be sure of how long he or she is going to live, a simple factor which acts as a disincentive to people to plan for an increasing income stream over a period of time.
2.2 In referring to flat annuities, the document does not address an issue which is a major problem with them, namely that any increase in inflation will have a dramatic effect on their real value. We believe that it is basically unfair for a retirement system to leave retired persons so exposed both to the annuity rates which prevail at the time at which they buy their annuities and then to sudden economic changes which can materially alter the value of their pensions in payment.
2.3 The text invites comments on the suggestion that providers should encourage individuals to shop around for the best annuity rates. We fully agree that, if it is to remain compulsory to convert the whole of one's retirement fund to an annuity, people should obtain the best possible rate that is available to them. Part of this involves making information available to prospective consumers. Distribution of material such as the FSA comparative tables and guide to annuities would be a step in the right direction. But obtaining the best product is also likely to require specific professional advice to be given to prospective purchasers.
CHAPTER 5 ISSUES
2.4 The text discusses the possibility of encouraging a greater range of providers to enter the annuity market. There is already a wide range of providers and we do not see the addition of new ones having a competitive effect on costs and rates. Any new provider should in any case be expected to fulfil demanding capital requirements. We question whether it would be desirable to expand the market to encompass small providers whose ability to meet their commitments could not be absolutely assured.
LIMITED PERIOD ANNUITIES
2.5 Given that it is already possible to buy fixed term annuities, we do not consider that the model outlined in the text and in Annex 4 is either a radically new initiative or an adequate response to the basic problem in annuity provision. In fact, the proposed limited period annuities could have the effect of increasing costs and driving conventional annuity rates even further down. They would also add to the complexity of the current system without providing any meaningful way forward.
3 An Alternative Approach
3.1 As we have suggested in our comments thus far, we believe that the drawbacks of the current obligation to buy annuities are not capable of being remedied simply by making cosmetic changes. The pensions environment is changing too quickly for that. There needs instead to be a new, unified commitment to retirement saving which acknowledges that a very wide spectrum of the population will rely for its pensions on money purchase plans.3.2 In the first instance, we believe that the tax system must restore tax relief on dividends. In current circumstances, we believe that encouragement to save for retirement must be given a new priority.
3.3 Secondly, we believe that the UK should adopt a new, more flexible approach to the withdrawal of income from a money purchase pension fund. We consider that the accumulated fund should remain the property of the scheme member post-retirement but that rules should require the member to withdraw a minimum income from it. This could be achieved in one of two ways. Either the member could be required to purchase an annuity sufficient to secure an income equivalent to the minimum income guarantee, as has been proposed in the Pensions Annuities (Amendment) Bill, with the member remaining free to invest the remainder. Alternatively, there could be rules similar to those which apply to 401k schemes, whereby a minimum distribution is required to be taken each year, on a progressive basis depending on age.
3.4 This alternative approach could incorporate other features including withdrawals of capital at any time for designated purposes, e.g. in meeting the cost of nursing homes, care, hospital treatment, etc., for which the present annuity arrangements are quite unsuited. We believe that the incorporation of features of this kind would have the potential to provide a major boost to pension saving.
3.5 Most importantly, there should be no requirement to exchange the whole of a capital fund for an annuity, the inability of annuitants to pass on any part of their accumulated funds to their descendants being a major flaw of the current system. On the death of the scheme member or his/her spouse, we propose that the residual fund could be subject to Inheritance Tax or a specific exit charge, thus ensuring that the Revenue recoups tax in return for the relief previously given on contributions.
3.6 The above notwithstanding, any new arrangements should still incorporate the freedom for scheme members to buy annuities at any time should they wish.