The biggest surprise in last week’s budget was the announcement that pensioners would no longer be obliged to buy an annuity.
Many people think of “a pension” as being an income paid to those who have ceased to work. The state pension and some employers’ pension schemes provide just that. However, more commonly a private pension is really just a pot of money saved up over your working life.
Because the government wants to encourage people to save for their retirement, pension savings benefit from generous tax reliefs. However, in return for this (and to avoid people falling back on the state pension) accessing pension savings has always been tightly controlled – until now.
Currently, you are obliged to use most of your pension savings to buy an annuity. This means paying your savings to an insurance company, which in return provides you with a regular income until death. However, partly because of low interest rates and increased life expectancies, annuity rates (the amount of income you get for each £1 you pay) have been falling for many years.
Last week, the government announced that from April 2015 the obligation to buy an annuity would cease. Instead, people with private pensions will be able to withdraw all of their savings and use them as they see fit.
This surprise change has already had a big impact on the annuity market. Insurance companies have been able to rely on between £12 and £15bn being spent on annuities each year, because pensioners are compelled to buy one.
In Australia, where it is not compulsory to buy an annuity, only 1 in 25 people buy annuities out of choice. This potentially huge reduction in the annuity market initially caused sharp falls in the share prices of annuity providers. Larger insurers (for whom annuities are only a small part of their business) fared better than specialist annuity providers, some of whom lost over 50% of their value virtually overnight.
Insurers will now have to adapt their offerings to pensioners to make them more attractive. Some are predicting that the changes will result in another property boom, as pensioners use their pension savings to pay off their mortgages or invest in other property. Others predict that asset managers will gain from those wanting to invest their pension savings.
Only time will tell, and, who knows, maybe even annuity rates will become more attractive again?
Rob Morris is a partner in the insurance group at RPC.