Compulsory annuities scrapped in pension shake-up

But pensioners will need to have a pension income worth at least £20,000 a year to take advantage of the greater flexibility, according to details within draft legislation of the 2011 Finance Bill (see the Free Annuity Guide).

The minimum income requirement has been introduced as a safety net to prevent people from using up all of their retirement savings too soon and becoming a burden on the State.

Anyone with £20,000 or more pension income per year will be able to draw money from their pension pot, known as income draw down. Anyone who has less will have the amount they can draw capped.

The Association of British Insurers (ABI) stresses annuities are still crucial in offering a guaranteed pension income in retirement to those with smaller pension pots.

When picking one, it is vital you don't automatically choose the plan offered by your pension provider. Instead, search the market as better deals may be available that could boost your income by tens of thousands of pounds over your lifetime.

Greater choice

Some experts welcomed the pension changes for giving people greater flexibility over the way they use their pension, which is hoped will encourage more people to save for their retirement.

Helen White, acting director of life and savings at the ABI, says: "The new flexibility will allow pensioners to take their retirement income in the most appropriate way for their own circumstances."

In contrast, Michelle Mitchell, from charity Age UK, says: "We are extremely concerned about the very significant risks including the mis-selling of complex and expensive alternative products and real hardship for many pensioners if the value of their investments falls or they live longer than expected."

White argues that the minimum income requirement would "protect people from depleting their pension pots and falling into poverty unnecessarily".

Under current rules, the 7.8 million people who are currently saving through a defined contribution pension and those with a personal pension have to use their pension pot to buy an annuity, which provides them with an income for the rest of their life, by the time they are 75.

But the rule was introduced in 1976, when the average man who had reached the age of 65 was expected to live for only another 13 years.

Today, men aged 65 who are in good health have a further 21 years of life expectancy, while women have a further 24 years.

Government plans to enable people to work on past the default retirement age also mean that having to buy an annuity by the age of 75 is likely to be unsuitable for growing numbers of people.

The Treasury is also slashing the tax rate on funds remaining at death from 80% to 55%.

White says this will "reduce the incentive for pensioners to empty their pots as rapidly as possible to avoid high charges on death".

State pension to rise

The news comes in a big week for pensions.

Yesterday, the Department for Work and Pensions revealed the basic state pension will increase by £4.50 to £102.15 a week in April while the majority of working age benefits will be increased by 3.1% (see the State Pension Boosting guide).

Low income pensioners will also benefit, as most pension credit recipients will see a £4.75 increase so they are guaranteed a minimum £137.35 a week minimum income.

The Government also stopped short of giving companies the power to pay lower pensions to workers than they had previously promised.

Pensions Minister Steve Webb says companies that promised they would increase final salary pensions in line with the Retail Prices Index (RPI) inflation measure each year would not be allowed to switch to the Consumer Prices Index (CPI), which tends to be lower.

The Government announced in July the minimum rate by which occupational pensions for retired and deferred members must be increased was being changed from RPI to CPI, in line with public sector pensions and state benefits.

The move will affect all pension schemes that promise they will raise benefits each year in line with the minimum level set by the Government, but it will not affect those that say they will increase pensions by at least RPI.

Nevertheless, it has been estimated that members of affected private sector funds will be £77 billion worse off.

There had been speculation the Government would allow such a change among firms that offer an RPI guarantee, sparking anger among unions and concern among industry commentators that the move would enable companies to make changes to pensions that had already been accrued for the first time.

Further reading/Key links

Pension help: State Pension Boosting, Free Annuity Guide Best rates: Top Savings, Top Fixed Savings Stay safe: Safe Savings