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Mr. Curry: Because people can invest in a retirement investment fund, money that would otherwise have been compelled to go into gilts can go into alternative funds and take the pressure off gilts.

Mr. Gardiner: I appreciate the point that the right hon. Gentleman makes only too well. Current legislation provides that people can defer purchase of an annuity until 75, but he suggests that the annuity must be purchased at 65. I agree with his point but I am sure that he will agree that many annuity purchasers do not have the extra income to do what he suggests. Many people also find it difficult to understand the issue and simply put their money immediately into an annuity.

Mr. Flight: The overwhelming majority of people already buy an annuity at 65. The issue that the hon. Gentleman raises could be covered in much greater depth in Committee, but it is not correct to argue that the Bill would result in a massive increase in the amount flowing into annuities at 65.

Mr. Gardiner: I look forward to further debate on these matters. I do not think that the picture is quite as the hon. Gentleman paints it, but we need to take seriously the effect that the Bill might have on gilts. Nobody wants a perverse effect under which annuity rates would be driven down even further by these proposals. I am sure that we would all agree on that point.

The three factors that I have outlined are good things, in and of themselves. It is good that people live longer. It is good that inflation is low, and I hope that we would all agree that it is good that the Government can borrow cheaply. The problem is that those three factors combine to reduce annuity rates. That does not mean that annuities

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are, in today's market, bad value. In fact, indexed annuities are relatively cheap, and annuities are still arguably the most efficient way of using pension capital to ensure financial security in retirement. Also, the substantial growth in the equities market over the past 20 years has increased substantially the value of the individual's pension fund as people retire. That rise has offset the decline in annuity rates that we have seen over the past decade for most pensioners as they retire. The contrast with the historic situation of pensioners is not as stark as some of the often-quoted statistics would suggest, and as some of the remarks made in the Chamber today might lead one to believe.

Having made that argument, I want to acknowledge a central agreement with the right hon. Member for Skipton and Ripon. The real issue for all of us, both the Government and the Opposition, is not whether annuities are a worse investment than they used to be, but whether we are enabling people to make provision for their pension in the best way possible. Obviously, if there are changes that we can make to legislation or regulations that allow people better to provide for their old age in security, it is incumbent on us to do so. It is very much in that spirit that I join the debate today.

The debate centres around a number of issues relating to annuities: the requirement to purchase one with money-purchase pension funds before the age of 75; the perception that they are poor value for money; the belief that they do not allow money to be inherited on someone's death; and the fact that they are inflexible and cannot cater for the different monetary needs that arise at different points during the ever-increasing retirement period.

The Bill attempts to address some of the issues by adopting the Retirement Income Reform Campaign proposal to allow, on retirement, an index-linked annuity purchase to meet a minimum retirement income to ensure that state support is avoided. The Bill seeks to give greater freedom in using the remainder of the residual fund to re-invest in the retirement income fund, which will be unrestricted in terms of when and how much income could be withdrawn from it.

If we are to examine these proposals' ability to deliver the reform of annuities, it is necessary to understand what the Government's response to date has been, as there has been little consideration of what criteria the Government should use in evaluating alternative options for reform. To date, Ministers have yet to give a single definitive announcement of the criteria that they would like to use. As observers of the Government's every move—as we are on the Labour Benches—it is possible to deduce two of the main criteria, based on announcements already made by Ministers and Departments.

At a fringe meeting at the TUC conference in September last year, the Minister for Pensions publicly rejected some of the alternative proposals related to the Bill on the basis that only the rich would benefit. It is important to quote what he went on to say:


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Similarly, the Secretary of State for Work and Pensions said in the House:


Her Majesty's Treasury, in responding to calls for reform from the Retirement Income Reform Campaign, concentrated, as might be expected, on the costs of reform. Any reforms are likely to need to avoid significantly increased costs to Government, including increases in tax relief. That was clearly underpinned in the pre-Budget statement on 27 November, when the Chancellor again spoke of the Government's support for annuities and the secure income, through retirement, that they provide. He also pointed to the continued development of the product range, which I trust Members will agree has occurred, and which has resulted in pensioners having more choice.

The Chancellor went on to announce his plans to consult on how better to promote competition in this market and thereby improve benefits to customers. The poor use made of the open-market option facility was specifically raised.

Without the privileged insider knowledge of a Front Bencher, it is only possible to draw conclusions from those announcements. It therefore seems that the main Government criteria for successful reform of the annuity system are twofold—the protection of Government revenue and an improvement in the situation of all annuity buyers. I wholeheartedly support those criteria and I urge right hon. and hon. Members to do so as well. In practice, there will be two aspects to protecting the Government's fiscal position—ensuring the payment of tax on the proceeds of pension funds and keeping pensioners' incomes above means-tested benefits levels.

One area that I do not wish to cover is the further impact on Government revenue if the changes in annuity rules result in changes in patterns of saving behaviour. For the sake of today's debate, I will assume that there will be no change in that behaviour, and conduct my analysis accordingly. However, that is another factor to be addressed, perhaps in Committee. The second-order effects are difficult to measure, particularly as they are likely to be affected by other changes in pension policy, such as the introduction of the pension credit.

I shall concentrate on the impact on Government revenue and reform of the whole annuity system, assuming that no change in savings behaviour would result from the Bill. Commendably, the proposals in the Bill and those of the Retirement Income Reform Campaign have been promoted as specifically trying to avoid loss of tax revenue on pension funds. The proposals allow for all the pension fund that is not annuitised to be taxed on withdrawal; they will therefore balance any imbalance that may occur to the Treasury. The campaign's working paper says:


The Bill also takes into account the means-tested benefits system by requiring the purchase of an index-linked annuity to provide a minimum retirement

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income. The level is rightly set to ensure that, on reasonable assumptions, individuals will not have an income below the means-tested level during their retirement. Otherwise, the individual would become dependent on state benefit and the proposal would fail the test.

The Retirement Income Reform Campaign, in a communication referred to in House of Commons Library research paper 0118, has suggested that MRI would be pegged at £140 a week. That level represents the income produced by the basic state pension and SERPS for someone formerly on national average earnings—£140 a week at the time of that communication, and from next year around £160. That option was recommended on the grounds that it struck a suitable balance between flexibility and certainty and because it marked a link between the income produced from contracting out of SERPS and the income which would have been produced by staying contracted in.

That figure was first suggested in March 2000, when the minimum income guarantee was £75. The MRI would have to be much higher than the MIG because the Government, commendably, intend that MIG should be uprated in line with earnings. Most other income sources in retirement will increase in line with prices.

From April 2003, the MIG will be £100 a week. From October 2003, the Government will introduce the pension credit, a reward for private saving that will extend means-testing to those with incomes in retirement of £135. In future, it has been suggested, the upper limit is likely to rise faster than earnings as the gap between the MIG and the basic state pension increases. That suggests that if the MRI is to ensure that individuals do not fall back on means-tested benefits, it will have to be much higher than £140.

Take the example of someone who purchases an annuity at 65 and has a life expectancy of 15 years, the figure in the Government Actuary's interim life tables. With real earnings growth of 1.5 per cent. a year and an income increasingly in line with prices—currently 2.5 per cent. a year—the MRI would have to be around £195. That would ensure that people, on average, did not fall back on the state, but those who lived longer than 15 years would do so, and the MRI might therefore have to be even higher.

The MRI would also have to increase over time. The income at which pension credit is payable would be higher for those retiring in later years. Even assuming no increase in life expectancy, they would need a larger MRI to ensure that they did not fall back into means-testing. Consider someone who retires five years after the pension credit is introduced. That person would need an income of more than £350 a week 15 years later. That would mean an index-linked income of almost £250.

An MRI at such a level, which is needed to protect spending on means-tested benefits, would obviously have a significant impact on the number of individuals who would be able to take advantage of the Bill's proposals. Assuming receipt of a full basic state pension in 2003—£77 a week—and an index-linked MRI of £200 a week, a fund of £95,000 would be required. That is significantly higher than the funds for the vast majority of annuity purchases.

Although income from SERPS and occupational pensions will reduce the amount needed from annuity income—though not for the self-employed—evidence

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from the Aberdeen Asset Management retirement income survey suggests that few of those who retire over the next 20 years with annuities will have retirement income at that level. In fact—a killer fact as far as the Bill is concerned—fewer than 5 per cent. of those who retire will have that income, assuming that there is no increase in the MRI.

The Bill therefore fails to protect Government revenue, unless it is increased greatly above the level proposed by the Retirement Income Reform Campaign. It also fails to deliver an improvement for all annuity buyers since it would benefit only 5 per cent. of them.

Further implications in respect of the impact of the Bill can be seen when working through the income generated in retirement and the amount of capital remaining for one individual with a pension fund of £25,000 on retirement. Let us contrast the two options.

Under the existing system of annuities, let us assume that the individual buys a level annuity and receives a nominal return on capital of 6 per cent. Let us compare that with what would happen under the Bill, which is based on a retail prices index-linked minimum retirement income of £140 a week. No allowance is made for any state benefits.

The answers that unfold are simply staggering. The income in retirement for individuals with smaller pension funds is initially lower under the proposals made by the right hon. Member for Skipton and Ripon. That is because the Bill requires the pension purchase to be index linked. That suggests that, at least initially, Government expenditure on means-tested benefits could rise. The index link does not mean that there may be savings in later years, but the individual is undoubtedly no better off and may even be worse off. A level annuity may give them income above the level of means-tested benefits, to which they then become entitled as inflation erodes their income. With an index-linked annuity, they may receive a lower income initially and still end up on the same income provided by means-tested benefits later in life. That could be exacerbated by differential mortality rates. Those with low incomes are also more likely to die at younger ages.

In the example that I have given, the right hon. Gentleman's proposals do not provide a capital sum that could be used other than the existing tax-free lump sum. So, in summary, the attempts in the Bill to protect revenue make his proposal applicable to only a small number of people. Perhaps fewer than 5 per cent. of those retiring will have an income above the revised MRI levels. Even with an MRI, there may still be extra Government expenditure on means-tested benefits.

The difficulty in meeting the apparently contradictory objectives suggests that, rather than requiring substantial reform of the annuity regime, the answer may lie in a better understanding of annuities, better access to advice on retirement income and the introduction of small reforms to the pension system as a whole.

Like many hon. Members, I am happy to claim credit for many things, but this morning I acknowledge my profound debt to an article written by Julie Stark and Chris Curry, which is to be published next week. It provides an industry view of the weaknesses of the Bill

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as well as the proposals made by the Faculty and Institute of Actuaries and the Tenon proposal. Therefore, I do not claim credit for all the analysis that I have just used.


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