Pension Annuities (Amendment) Bill

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Ruth Kelly: The right hon. Member for Skipton and Ripon cannot criticise these amendments on the ground that they are drafting amendments. They address a major aspect of the clause, and they are intended to correct an inherent flaw.

The Bill seeks to force all personal pension scheme members to use their funds to buy a minimum income annuity by the age of 65: any remaining moneys can be designated as a retirement income fund, from which income can be drawn at the will of the scheme member. The Bill removes an existing flexibility—the right not to buy an annuity until the age of 75.

It also sweeps away the current rules with regard to income withdrawals, which are designed to ensure that the fund is not under-drawn or over-depleted. The right hon. Gentleman has said that there are problems with those rules. We accept that they are not perfect, but they have a role to play. They ensure that pension funds are used for their intended purpose. They set minimum and maximum income limits to ensure that a reasonable income is drawn, and that the fund is not over-depleted. They also provide that income withdrawals must not be made after the age of 75 when, under the current system, a lifetime annuity must be purchased. The right hon. Gentleman has criticised the Government for talking about only people with large pensions funds who are able to benefit from some provisions. However, it is worth bearing in mind those who use the draw-down facility, considering how that facility is used, and examining the potential effect of its retention or abolition on the pension system.

The draw-down facility is popular with people who have very large pension funds. It attracts about a quarter of matured retirement savings by volume, although only about 5.5 per cent. of the transactions. It is clear that they are among the larger retirement funds, and their average value is more than £140,000. People have told the Treasury that the advantages of the current draw-down system include transparency

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and control. Additionally, there is potential for legacies should a person die before buying an annuity. Depending on how pensioners arrange their draw-down facility, they may have complete control over the part of the fund that is invested, and they need not delegate choice about the deployment of their funds unless they wish. People who choose draw-down systems usually value that transparent arrangement. They say that they do not wish to cede control of their pension assets to an annuity provider in order to retain equity exposure.

However, as the right hon. Gentleman alluded, draw-down systems involve considerable disadvantages, which I shall mention before I tell the Committee why I want the system reinstated. Draw-down inevitably exposes pensioners to mortality drag. If the right hon. Gentleman has read the consultation document, he will realise that although the public may not be curious about mortality drag, the Treasury and the Inland Revenue are fascinated by it. Mortality drag is the reason why annuity purchase is such a good deal for pensioners.

Mortality drag works in different ways, but it ensures that the longer a person waits before buying an annuity, the less efficient the use of their income. If a pensioner decides to invest his pot of money in equities before purchasing an annuity, he may benefit from the growth of that fund, which may be invested in the stock market or other securities. The growth might outweigh the loss of efficiency that is incurred by buying an annuity at a later date. Economic analysis suggests that around the point when a person reaches the age of 75, it becomes clearly more worth while to buy an annuity rather than waiting for further growth of a pension fund because that money becomes much less efficient.

Mr. Flight: The Minister and the excellent paper overlook a practical aspect of mortality drag. If we examine the present situation in which stock markets have been dramatically weak for two years, a person aged 75 whose pension fund might have fallen by 35 per cent. would understandably believe that that could recover in a further 18 months. That would offset the drag effect. The Minister's point is clear in principle, but the practical situation is not quite like that.

10.15 am

Ruth Kelly: Draw-down inevitably involves a degree of risk. Retired people take a gamble on the stock market with their pension funds. They make their own internal forecast, or rely on the advice of others about the likely future growth of the fund. They may come to the opinion that the fund is likely to fall over the next 18 months or two years. They may reach an opposite conclusion from that that the hon. Member for Arundel and South Downs has put forward, which means that they would buy an annuity earlier than they otherwise would.

Investing in the stock market involves a degree of risk. If one is risk neutral it may be worth deferring the purchase of an annuity until the age of 75, but for the majority of people who are risk averse, the age at which it makes sense to buy an annuity is significantly

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lower than 75. As the Committee knows, the Government have suggested 75 as the age at which buying an annuity should become compulsory.

I have already referred to the fact that people decide to use financial advice when using income draw-down because the decisions are complex. At the moment, the cost of financial advice for income draw-downs is considerable. One issue that we are exploring through the consultation document is whether there are ways in which advice charges, which currently reach 6 per cent. of the total nominal amount for income draw-down, can be reduced. We have explicitly asked about that issue in the consultation document.

Another way in which to make sure that the charges for income draw-down are lower than they are at present is to introduce the concept of a limited period of annuity. Instead of having to rely on income draw-down, which would mean incurring charges year after year, people will able to take financial advice at a single point. They will be able to buy an annuity for perhaps three or four years and then reassess their financial situation to ascertain whether it makes sense to buy an annuity. That will probably bring significant advantages to the group of people, who tend to be those with larger pension funds, that currently uses the income draw-down facility.

An important principle in the Government's attitude to annuity reform is the introduction of a limited period annuity, which will, if anything, cause the majority of annuity rates to rise rather than fall. It will do that by taking pressure off the long-term gilt market. It introduces the idea of backing short-term annuities with shorter gilt products, and, as the hon. Member for Arundel and South Downs knows, the gilt market is under great pressure and long-maturity index linked gilts are in short supply. Working for the benefit of the majority of annuitants is an important principle in annuity reform.

Mr. Field: The Minister is rightly drawing attention to the costs of some aspects of policies that allow money to be drawn-down. Has she thought of reminding the industry that it was not that long ago that the Government were a supplier of annuities? If they came back into the business, they could reduce those charges at a stroke. They have been immensely successful in reducing pension charges through stakeholder pensions; might a similar policy not operate here?

Ruth Kelly: I thank my right hon. Friend for his comments, which are useful. He should make those points to us in the consultation process.

One question we raised is by how much charges can be reduced. They are far too high, and most people who use the facility lose considerably on the charges incurred. The charges are unnecessarily high, and I hope that from the responses to the consultation process we shall see ways in which they can be reduced. Competition from limited period annuities may help to drive down charges. The flexibility to innovate in the market that we hope will be introduced following the

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consultation will also introduce an extra element of competition, which will lead to the market working better.

Draw-down also has an important flaw from a public policy perspective in that it has a current exit charge of 35 per cent. One lesson we have learned is that it tends to be people subject to higher rate taxes on their annuity income who take advantage of measures such as income draw-down. Many weeks ago, I asked what size pension fund one would attract 40 per cent. income tax on annuity income. The answer, depending on the type of annuity taken out, is between £300,000 and £500,000. That is not to say that there is a problem about acting for people with funds of those sizes, but it puts the subject in context. At present, 1 per cent. of pension fundholders have funds as high as £500,000. That gives a flavour of the number of people who would benefit from the proposals.

If the majority of people who use income draw-down are higher rate taxpayers, and we have an exit charge of 35 per cent., such people are not only benefiting from 40 per cent. tax relief provided by the Treasury, but from the tax-free investment growth of the pension fund while they have it. They are also benefiting from the fact that pension relief is given to pension funds as a deferred income to the Treasury, with tax later refunded through an exit charge—a period of deferment. Significant costs to the Exchequer therefore exist in the present arrangements.

Although draw-down has its limitations—we are trying to get the market to work significantly better—there is no reason for abolishing income draw-down rules, or for having no rules or constraints on the use of money after a certain retirement income fund has been set, as the right hon. Member for Skipton and Ripon proposes. That leads me to consider for the first time the costs that would be incurred were the income withdrawal rules abolished. We must consider the cost to the Exchequer of proposals that are put forward, particularly in private Members' Bills, because, unlike primary legislation, they do not benefit from huge resources and input, or from debates in the House of Commons.

One argument is that were we to scrap the income withdrawal rules, we would have a system in which there would be a huge incentive for people to start saving in pension funds; they could be sure in the knowledge that they could gain 40 per cent. tax relief on the tax-free investment growth of the fund, draw it down and use it for whatever purpose. However, that fundamentally misunderstands the purpose of what can be described as a ''contract'' between the state and individual. The contract is that we provide 40 per cent. tax relief provided that the individual member uses the money to buy a secure income in retirement. We provide that because it is important that people have an incentive to lock up funds for the long-term future, look after themselves and do not to fall back on benefits, and for no other reason. I have already

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explained other forms of saving that are available to people who do not want to take advantage of the current system.

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