The great retirement lottery
If you feel like you are getting a raw deal from your pension, sign our petition and join our campaign to get fairer annuities for all.
The majority of retirees are currently getting a raw deal when they come to draw an income from their pensions. The market for annuities - the lifetime retirement income that people buy with their pension pots - is fatally flawed.
The system sounds workable in theory: pension holders approaching retirement are provided with an annuity quote from the insurance company running their pension fund, but are free to shop around and find a better deal from other providers.
But it's not working: in practice two-thirds of pensioners simply accept the typically mediocre deal they're offered by their pension provider.
Zena Sandler, 63, a former director in the fashion industry, did just that when she retired three years ago and accepted the annuity offered by her pension provider, Aviva. "I didn't even realise you could shop around, and I wouldn't know how anyway," she says. "I was offered an Aviva annuity, and as we'd always been with the company, I stuck with it."
Part of the problem is consumer ignorance. Annuities are a crucial purchase because they determine the level of income you'll have to live off for the rest of your life. And once you've made your decision, there's no going back as you can't cancel or switch your annuity.
The biggest difficulty, however, is that pension companies profit massively from their 'internal' market of existing pension customers. A genuinely open market will only make things tougher for them, so they want to preserve the status quo.
Yet their greed means that retirees - who have already had to face the drying up of generous, secure final salary schemes (only three FTSE 100 companies now offer one to new employees), poor investment performance from their pension funds, and falling annuity rates - are likely to be even worse off.
Look out for enhanced annuities
The differences between the best and worst rates can be really significant. For instance, according to online annuity broker Annuity Bureau, a 65-year-old man with a £100,000 pension pot and an annuity offer from Standard Life could currently improve his annual income by almost 15% - an extra £1,000 a year - just by buying an Aviva annuity instead.
Many people are eligible for even more generous 'enhanced' or 'impaired' annuity rates because they have a medical condition - which could be anything from a weight problem or high blood pressure to cancer - that could reduce their life expectancy.
You could typically boost your retirement income by 20% to 30% by buying the top enhanced annuity, but it could be as much as 70% more.
London-based Salim Odish, 65, for example, called up the Annuity Bureau, having received a quotation from AXA for an annuity of £1,800 a year.
However, as business development consultant Phil Steel explains, a few questions brought to light the fact that he had diabetes, and a quick search on the open market revealed another provider offering £2,100 - a 16% improvement. "On top of that, by asking some lifestyle questions we were able to boost the offer to £2,300 a year - almost a 28% increase," Steel adds.
Of course, some customers are genuinely better off sticking with their existing pension provider - if they have a longstanding guaranteed annuity rate that beats anything currently available, for example, or because that provider happens to be paying a market-leading rate.
Take Linda Wriglesworth, 55, a bathroom designer and sales consultant living in York. She decided to supplement her earnings with a small annuity, using an Aviva pension fund worth about £30,000.
"Aviva encouraged me to compare rates in the open market, though I would have shopped around anyway, because we're all a bit savvier these days, I think," she says. "I did some research online and Aviva's rate came out top, so I took that."
Check out the market
The key to ensuring that people get the best income, given their pension pot and personal circumstances, is using what's known as the open market option. This was introduced more than 30 years ago, and pension providers have been legally obliged since 2002 to tell their members about their right to check out the competition.
But the fact is that these companies have a fundamental conflict of interest in pushing customers to take advantage of the open market option, because they do very nicely out of the inertia-driven annuities market as it stands. So it's hardly surprising that most people accept what they're offered, given insurance companies' reluctance to push the message.
Research by the FSA in 2008 found that almost 40% of insurance companies offering pension annuities weren't even giving customers the minimum information needed to comply with the open market option rules, and a further 44% just met the basic standards. Only 18% were meeting 'best practice' standards.
For instance, Legal & General reports that 50% to 60% of its pension holders go on to take an L&G annuity, while Aviva retains around 70% of its customers (although that's partly because Aviva's rates are typically among the market leaders).
So what's the big problem? As Steve Lowe, marketing director of retirement specialist Living Time, explains: "When most customers simply flop out of a pension and into the waiting annuity, insurance companies don't have to worry about paying competitive rates."
Furthermore, he adds, many of the big players - including L&G, Aviva and the Pru - get a lot of reliable business from cosy 'strategic partnerships' with other companies, from Openwork, Equitable and Royal London to Saga, which recommend that insurer's annuities to their customers as the preferred choice.
There's even less incentive for companies to help customers onto enhanced annuities. "Only 10% of those eligible for enhanced annuities actually end up with them," claims Tom McPhail, head of pensions research at broker Hargreaves Lansdown and chairman of pressure group the Pension Income Choice Association (PICA).
Again, the insurer stands to gain. "If the retiree is not on an enhanced annuity and then dies relatively early, it's the annuity provider that pockets the unpaid cash," explains Lowe.
Easy access to information?
The Association of British Insurers (ABI), the body that represents the big pensions companies, is adamant that its members are making big efforts to get the 'shop around' message out loud and clear. It says it has simplified and made more accessible the 'wake-up packs' sent out to tell customers of their annuity choices as they approach retirement.
However, the Pensions Regulator disagrees. "Our research shows that standards of information are mixed. Literature should grab members' attention and motivate them to take action, rather than putting them off with jargon or legalese," says acting chief executive Bill Galvin.
Moreover, the important information may still be tucked away: the Pru's reminder brochure (sent six weeks before the retirement date), for example, relegates details of the open market option to page 16 of the 20-page booklet.
One or two providers have taken additional initiatives, but they're in the minority. As Ros Altmann, pensions campaigner and director general of Saga, says: "Too many providers are engaged in sharp practices that leave pensioners with inadequate retirement income."
A new system
Moneywise believes it's time for a different system that deprives the insurers of their ready-made market and makes it really straightforward for people to compare rates as a matter of course.
Some retirees also have a sense of misguided loyalty, believing that their pension provider of many years will 'reward' their longstanding custom with a competitive offer. Others may be worried about the additional costs of using an IFA for advice if they are faced with a wider choice.
PICA's perspective - which Moneywise supports - is that the open market option has run its course and wholesale reform of the system is needed.
We want to see a change in the default position for all retirees from 'stick with your pension provider' to 'review all your retirement income options'. It's a controversial proposition, but one that is attracting increasing support from influential politicians including Mark Hoban, financial secretary to the Treasury, and pensions secretary Steve Webb.
At Moneywise, we think it's time to end the pension companies' complacency and introduce a genuinely open retirement income market. Next month we'll look in detail at PICA's proposals and the implications for retirees.
Our mission statement...
Moneywise calls for:
- An end to the exploitation of apathetic or ignorant consumers by the companies that hold their pension funds.
- A system that encourages every retiree to review all their retirement options with an open mind.
- High-profile education to highlight the importance of shopping around.
- Support and guidance in decision-making.
- Affordable 'direct' alternatives for those who can't afford or don't want to take independent advice.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Open market option
People who have a money purchase or defined contribution pension, at retirement must use their fund (minus an optional 25% as tax-free cash) to purchase an annuity. As the annuity market is very competitive and rates differ vastly between annuity providers on a daily basis, the open market option is your right to shop around and buy the annuity from the company offering the highest rates at that time.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.