Pension Annuities (Amendment) Bill

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Mr. Flight: Has the Minister any evidence that in Canada or Ireland, where the obligation to buy annuity has ended, there has been the much-feared increase in pension saving, to which she refers? I understand that not to be the case. Although everyone is entitled to an opinion, I argue that the attractions of a 40 per cent. exit charge are not likely to stimulate a huge increase in pension saving. My worry is that pension saving is moving in another direction—it is going to hell.

Ruth Kelly: The hon. Gentleman points to what we can learn from international experience. Several things can be learned, although differently designed pension systems exist, so it is not easy to draw close parallels. If rules do not lock in money for the long term, and people are allowed to draw it down, they tend to underestimate life expectancy and deplete funds too early during their retirement. We do not want to see that happen.

Life expectancy is increasing rapidly: I am sure, and I hope, that that will continue. People, for whatever reason, are prone to think that they should withdraw too much money, or to underestimate the length of time that they have to live. Consequently, they draw-down money too early in their retirement, deplete their funds and fall back on means-tested benefits at a later date, which is undesirable for the state and the people concerned.

At present, the annuity is the only financial product that guarantees a secure income stream, no matter how long a person may live. It provides not only a secure income stream that allows people to extract their capital in a financially efficient way, but by pooling risks it allows those who live longer to benefit from those who die earlier, to put it crudely. In that sense, they are protected and have a genuine income stream that does not suffer as a result of their good health. They can use the benefits of the pooling system in the insurance market. Once that principle and the rules on income withdrawal are got rid of, one is left with a system that provides 40 per cent. tax relief. The state contributes about £30 for every £100 in a fund, which people can use for any purpose.

That will not increase pension saving, as the hon. Member for Arundel and South Downs suggests. Saving in pension funds may increase, but the amount of money that people provide for their retirement income will not. People will shift from other forms of saving into pension funds, free in the knowledge that they can use those funds for the same purpose that they used their previous savings.

Mr. Jim Cousins (Newcastle upon Tyne, Central): Would my hon. Friend accept that in the American 401K plans, which are the model for stakeholder pensions to an extent, there is provision for drawing down pension funds for other significant lifetime events? For instance, one might need provision for residential care, or the financing of higher education.

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It would be possible to design rules that would protect the integrity of pension funds, while allowing more flexibility in their use.

Ruth Kelly: I am interested in my hon. Friend's contribution. He may have studied the 401K pension scheme more closely than I have. If so, I would be interested to continue the debate. From my cursory understanding of the 401K scheme, I believe that the Americans are having difficulty with people extracting capital for legitimate reasons, but ones other than securing a long-term income in retirement. They also face the problem of people falling back on state benefits later in retirement and underestimating the need for locking away long-term savings.

Mr. Cousins: That is a fair point, but surely the Minister is not saying that the United States is attempting to redraw the rules of the 401K plan so that no such draw-down is possible? It is considering making the rules more rigorous, which is entirely consistent with the matters before the Committee today.

Ruth Kelly: I would not say that the Americans are considering rewriting their 401K schemes: I have no precise knowledge of the internal debates that took place in the United States on that score. However, in the US, people are very restricted in their other savings vehicles. In the UK, we have the benefit of individual savings accounts, introduced by this Government, that are designed to encourage low-paid people and even non-taxpayers to save for the short or the long term. People here have a great deal of flexibility over how they use those funds, but I believe that there is no similar savings vehicle in the USA. Greater flexibility in the use of the 401K pension scheme is essential if people in the US are to provide for themselves.

10.30 am

Mr. Cousins: One reason why the equivalent of the individual savings account is not required in America is because there is flexibility in the 401K plans.

Ruth Kelly: I hope that my hon. Friend is not suggesting for a minute that we abolish individual savings accounts or other savings vehicles here.

Pension funds are highly tax advantageous precisely because one has to lock away one's money for a considerable length of time, longer than people might naturally choose, given the everyday circumstances and difficulties that they face and the need for contingency, or rainy-day, savings. It is very difficult for people to choose to lock away sufficient money for their retirement. That is why we have rules that require people to buy an annuity by the age of 75 and income withdrawal rules that ensure that the fund that someone has set aside is not unduly depleted and can still provide for a secure income in retirement by the age of 75.

If people survive as long as 75, it is likely that they will have a considerable period of further life expectancy. I do not have the figures in front of me, but I might be able to find them to give to the Committee later. It is a very important point that if people reach

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the age of 75, they must be in a position to provide for themselves for a significant length of time. I would benefit by having those figures here, because they are interesting. Someone who reaches 75 will typically have a life expectancy of about a decade—10 years for men and 12 for women. Those averages conceal a significant dispersion. Of people who reach the age of 75, 8 per cent. of men and 13 per cent. of women live for another 20 years.

I do not know how prepared my hon. Friends and hon. Members would be for such a future life expectancy at that age, but I do not think that it would strike me as likely that I would live for another 20 years. There is, however, a real chance that my income would have to last that long, which is why it is essential to be able to buy an annuity that provides a secure income flow in retirement. It is an uncertain time when people are very vulnerable, and it is essential that they make the correct choices and do not lock themselves into the wrong annuity. We have tried to open up options in the consultation paper so that people do not lock themselves in for perpetuity, but have the option at several fixed and regular points to examine providers and see whether they have the best deal. We are opening up various ways of introducing greater competition into the market.

I return to the cost of stripping away income withdrawal rules. Currently, 40 per cent. tax relief is provided under the contract between the individual and the state. After tax from current pensions and payments is taken into account, the cost to the Exchequer of pension scheme tax relief is estimated to be about £12 billion a year.

People often choose to take tax-free lump sums, and that is another cost to the Exchequer. Presumably, if more people were encouraged to use pension schemes as a savings vehicle, the Exchequer would lose more tax on the tax-free lump sums that people can draw down. However, what would probably happen is that people who use other pension vehicles would start to transfer their savings from other pension vehicles into a pension fund.

To calculate the true cost of the reforms that the right hon. Member for Skipton and Ripon suggests, we must take into account the unused tax reliefs that people could take advantage of if they switched their savings from other vehicles into pensions. There is room for a further £34 billion of reliefs each year under the current tax limits. Of course, if people are not able to save more, they will not be able to shift money from other savings vehicles into pension funds; however, even among higher rate taxpayers there is £8 billion of unused tax relief. It may be that higher rate taxpayers are already saving all that they possibly can and that they will not take advantage of the extra tax relief through pension funds. However, a large proportion of that group is saving significant sums in other vehicles, such as ISAs, property, life insurance products and so on.

Mr. Curry: I am anxious to identify the people who will cost the Treasury £34 billion. Are they people with private pensions that are not high enough for maximum relief? Are they people who do not have

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private pension funds but who may be attracted to them? Is the amount based on the total compos mentis population of the United Kingdom applying for the whole of the tax relief on private pensions? I wish to identify those who may be queuing outside the Treasury for these tax reliefs, because £34 billion is a large sum. To form a judgment about the probability that people will take advantage of the reliefs, we must know who they are.

Ruth Kelly: The right hon. Gentleman raises an important point. I was about to say that not everyone will take advantage of the new headroom in pension funds. In fact, there is a strong argument that many who have pension schemes are already saving to their maximum.

Mrs. Browning: I wish to return to additional voluntary contributions. The proportion of AVCs to make up the maximum 15 per cent. contribution is not subject to a tax-free lump sum but must be taken as an annuity. For example, we contribute 6 per cent. of salary to the parliamentary pension scheme. There is little incentive to put in another 9 per cent. simply to buy an annuity, which is very bad value for money.

 
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Prepared 14 February 2002