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The Economic Secretary to the Treasury (Ruth Kelly): It is a pleasure to take part in the debate. I congratulate the right hon. Member for Skipton and Ripon (Mr. Curry) on securing his private Member's Bill slot. I also congratulate him on his application for the Bill, which, as he said, required courage, and on being successful in the ballot, which, as he said, required good luck.
I congratulate the right hon. Gentleman, too, on choosing the most complex of subjects, although I am not sure whether that required courage or foolhardiness. Whatever it required, I congratulate him on choosing a subject that represents a challenge to us all. We face not just an intellectual exercise, but the realisation that pensions, pension products and annuities have an impact on the lives of real people, their security in retirement and their savings behaviour. I congratulate him, finally, on the clarity with which he put his arguments. Like other hon. Members, I found his speech most entertaining.
The right hon. Gentleman has received advice from the Retirement Income Reform Campaign on the substance of his Bill. I have had the pleasure of meeting representatives of it and its chair, Dr. Oonagh McDonald, and I have discussed the proposals with them in some detail. I am grateful for their contribution to the debate. I am sure that once proceedings on this private Member's Bill have concluded in whatever way, we shall continue negotiations and debate with all interested parties. I am certainly committed to exploring workable and affordable ways of reforming the current annuity structure to improve choice and give people more control over their pension products. That is why the Inland Revenue and the Department for Work and Pensions will shortly publish a joint consultation document on how we might make the annuities market work better for pensioners. I hope that that document will deal with some of the issues that have been raised with passion and knowledge here today.
However, there are fundamental problems with the Billproblems that are inherent in the Bill and could not be resolved by amendment in Committee. It might be useful to hon. Members if I sum up briefly some of the main problems before I go through them in more detail. I believe that the Bill would be costly, and that the cost could run into several hundred million pounds. The Bill would be counter-productive and restrict choice for the majority of pensioners. It could also drive down annuity rates further.
The Bill would reduce flexibility and would not fit well with proposals for making the retirement age more flexible. I reject the charge that we are not willing to act because in some sense we are not prepared to give greater flexibility to those with larger pension pots. Those issues are fundamental to the content of the Bill. If we accepted that, we would restrict choice and flexibility for the majority of pensioners who seek to draw annuities.
It is important for me to start with an explanation of what the current annuity system is designed to do and what annuities are for. It is important to recognise that annuities are the single financial product that can provide a guaranteed income to people in their retirement, no matter how long they live. I hear hon. Members, including my hon. Friend the Member for Brent, North (Mr. Gardiner), suggest that we could consider other ways in which secure income for retirement could be provided, but at the moment they do not exist. Annuities are the only way in which a pensioner can be guaranteed a secure income in retirement, no matter how long he or she lives. Successive Governments of either persuasion have found the annuity system appropriate for just that reason. With people living ever longer today, annuities provide that important security.
The minimum retirement income is to be left to the Government to set annually. I understand that the idea, which has been explored in debate today, is for the MRI to be set at an amount that would ensure that the pensioner did not fall back on means-tested state benefits. Otherwise, the Exchequer could end up paying twiceonce for the costs of the pension scheme tax reliefs on a person's pension fund and a second time for the cost of state support.
Let us suppose that the annuity level was to be set at the level of the minimum income guaranteecurrently £92.15 a week, or £4,790 a year. I realise that my assumptions are cautious and that other speakers in the debate have assumed a much higher figure£140 a week or even more. However, if we assume that the amount is £92.15 a week, the cost of providing that income for a 65-year-old manat the best annuity rates currently availablewould be about £54,000. Assuming that people took their maximum tax-free lump sum, the necessary fund size would be about £72,000. If the annuity were index linkedas the Bill would requirea fund of about £95,000 before deduction of the tax-free lump sum would be needed.
That makes no allowance for those who want the minimum retirement annuity to continue to their survivor after their death. The cost of such an annuity would be significantly more, requiring a fundbefore deduction of the tax-free lump sumof more than £109,000.
Members may like to know that most people retire with pension funds of far less than that amount. The average size of pension fund accumulation is about £30,000. We are talking about the difference between £30,000 and £109,000that is what would be required to meet the MRI. About a quarter of the fund is taken as a tax-free lump sum, leaving even less available for annuity purchase. The average amount spent on each pension annuityas I understand it from figures provided by the ABI in 2000was actually £23,000.
Mr. Webb: I may have misunderstood the Bill's provisions, but surely they would mean not that the whole of the minimum income guarantee would be replaced, but only the marginal amount above any basic pension or other pension. The amount to be replaced would not be £92 a week, but about £17 a week at current ratesa fifth of the amount suggested by the hon. Lady.
Ruth Kelly: The hon. Gentleman is probably aware that the rate of the minimum retirement income is left to be set by the Chancellor of the Exchequer in a yearly order. Furthermore, the right hon. Member for Skipton and Ripon has proposed, both in the debate and in his press releases, that the amount is likely to be about £140 a week. That would, of course, include the basic state pension. If that figure were not included the level would fall, but other benefits might apply, such as housing benefitto which the hon. Member for Northavon
I realise that some people hold more than one personal pension fund, but the Bill would benefit only a small section of the populationthose people able to build up pension funds large enough to take advantage of the opportunities provided by the Bill. Under the measure, the majority of people would still be required to use the whole of their pension fund to buy an annuity. Not only would they gain nothing from the Bill: they would actually lose. I shall return to that point later in my speech.
Some people may say that an annuity of the size of the minimum income guarantee would be excessivea point made by the hon. Member for Northavon. In addition to taking into account the benefits I mentioned earliercouncil tax benefit and housing benefitwe should remember that the Government are committed to raising the MIG in line with earnings, at least during this Parliament. The value of the annuityindexed by reference to the retail prices index and capped at 5 per cent., as the Bill proposestogether with the basic state pension would be likely to fall steadily behind a minimum income guarantee that increased in line with earnings. The annuity would not then provide the protection against falling back on state benefits for which it was designed.
For the proposal to be effective, the MRI annuity would need to be linkedlike the MIGto earnings. No such annuity product exists, and it is unlikely that the industry would ever be able to develop such a product, as there is no matching funding vehicle to back it.
People's needs and financial circumstances differ greatly. Some may not have built up an entitlement to the full basic state retirement pension, so a requirement to build an annuity to cover only the difference between the basic retirement pension and the minimum income guarantee would often be inadequate for that reason. I am sure that hon. Members would not agree that the minimum retirement income fund should be set differently according to people's individual financial circumstances and I do not believe that that is the intention of the Bill. It would be wholly impractical, as well as an unnecessary and costly intrusion which could only increase the cost of annuity purchase.
There is another issue concerning value and freedom of choice. Index-linked annuities provide the very valuable guarantee that the purchasing power of the person's pension will not be eroded by inflation, but, as with all guarantees, there is a price. In the case of index-linked guarantees, that is paid by the person's receiving a lower level of income at the start than they would from a flat-rate annuity, which pays a fixed level of income throughout. The hon. Member for Northavon made some valuable and interesting comments in that regard.
If one assumes that the average level of inflation is about 2.5 per cent., it could take about 15 years before the income from an index-linked annuity matches that of a comparable flat-rate annuity. Many people, particularly those with modest pension pots, needor even preferto maximise the amount of income that they have earlier in their retirement, perhaps if they think that they will be
The opportunity, if a number of small personal pension arrangements are held, of taking a selection of different annuity types at different times can enable a person to spread risk. The Bill would remove that opportunity. For the very small minority of people who have large enough pension pots, who would perhaps benefit from the Bill, that loss of flexibility might be a small price to pay, but for the majority of pensioners the Bill would represent a significant backward step.
The important point is that people now have a choice. They can use their open-market option for annuity purchase. They have the freedom to decide which type of annuity best suits their needs. The proposals in the Bill would take away that choice.
The requirement for everyone to buy an index-linked annuity would also increase insurance company demand for index-linked gilts. The stock of index-linked gilts is limited. The present Government have been taking measures to ensure that index-linked gilts are still available up to a point, but even so the stock of index-linked gilts is limited and there are far fewer corporate issuers of index-linked gilts than fixed-rate bonds. It is not clear how that demand could be met.
I suspect that if there was a requirement for annuities to be index linked at the age of 65, current annuity rates would deteriorate. The vast majority of pensioners would then not only lose choice and flexibility but get worse rates on their annuities than people currently fear.
The Bill would force people to buy annuities not at the current age of 75 but 10 years earlier, at age 65. Most people would have no option but to withdraw all their pension benefits from age 65, whether or not they were retired, again limiting the choice that they currently enjoy. That introduces inconsistency and unfairness, in that the requirement to annuitise by age 65 would apply only to personal pensions but not to retirement annuity contracts or defined-contribution occupational pension schemes, which are left as they are.
However, there is a much larger issue in respect of flexibility and the age of 65. If people are compelled to take out an annuity at the age of 65, they cannot continue to contribute to their personal pension scheme past that age. They have to retire at the age of 65.