Compulsory nature of purchase raises concern

The debate about annuities continues with concerns being raised not just because the interest rates at which they are secured have fallen to dramatically low levels but also about the compulsory nature of their purchase. This latter issue is particularly serious since retirees must not only make irreversible decisions about their own incomes when they turn 60 or 65, but must also make similar decisions on behalf of their spouses and dependants.

The compulsory nature of annuity purchase is something that has been addressed - though not as extensively as many advisers and actuaries would like - by the National Pension Policy Initiative report that came out last May. It is hoped that following the report, newly retired people will in the next couple of years be able to postpone buying an annuity until they are at least 70 and that a portion of the pension fund will also be available for a drawdown before retirement. The extremely low annuity rates currently on offer means that someone with a personal pension plan, AVC or a defined contribution occupational scheme has not only been at the mercy of volatile stock markets during the contribution stage, but is now at the mercy of the same volatile environment at retirement. If the markets are down - as they are at the moment, the pension fund may very well be affected if it has not been prudently switched from equities to secure cash funds. The price of the annuity which must be bought at retirement, however, is also linked to the price of government gilts which in turn are affected by equity values and interest rates. Worse yet, however, is that the pensioner is not the only one that will be caught by the low annuity rates. The law stipulates that on retirement day, the retiree must also commit his or her spouse or dependants to that same reduced pension income. It cannot be reconsidered at a later date - there is no deferral period for the spouse either.

Most pension holders opt for a spouse's pension after their death that will work out at about half the value of their own. However, although the spouse's pension may not be paid out for many years, the very act of designating that it should be, will seriously reduce the value of the main pension. Another decision that will impact on the value of the pensions is whether to index them in line with inflation, typically 3 per cent. An escalating pension is meant to keep your income increasing in value each year, but some advisers argue that the starting point of the income is so low that an escalating pension is only of real merit if the pensioner lives longer than the life expectancy period. Typically, this is 15 years for someone retiring at 65.

Mr Gervase MacCourt of MacCourt Financial Planning in Dublin clarified some recent figures that were produced in these columns by himself and another pension commentator; Mr MacCourt is against escalating pensions, the other commentator was in favour of them. Joint life escalating pensions, Mr MacCourt agreed, would produce impressive returns - £8,330 a year for the husband and half that amount for the wife from a fund of £137,353, "but only," he writes, "if the figures can be reconciled with actual quotations." The only escalating pension figures he could come up with for this example, was a £6,620 annual income for the husband and just £3,310 for the wife upon his death. This reflects the quoted annuity rate for the couple of 4.84 per cent. In comparison, a pension for this couple which is not indexed would amount to £9,373 a year for the husband and £4,686 for the wife after his death, reflecting the higher annuity rate of 6.84 per cent.

Mr MacCourt stands by his initial views that escalating pensions are poor value against flat pensions in today's climate. "It takes 10 years from age 65 to age 75 before the escalating pension payment reaches the same annual payment as the flat one. It takes a further eight years - to age 83 - before the total accumulated pension payments on the escalating pension reach the same level as the flat one. If the pensioner on the flat pension were to save his extra pension payments (after tax) in the early years and build up a reserve fund, it would take a further three years (to age 86) before the reserve fund would "dry up".

His advice, and one shared by other annuity experts, in light of low annuity rates, compulsory purchase and the devastating effect of escalation is "that all annuity/pension quotations are accompanied by a full fact sheet showing a comprehensive comparison between an escalating and flat pension." Not doing so, they say, could be a mistake you regret for a lifetime. (MacCourt Financial Planning can be contacted at (01) 6614800. The Moneywise Annuity Bureau, which specialises in annuity purchase can be contacted at (01) 6705938).