Reaching the golden age

Mike Morrison takes a look at the age 75 debate

One of the most contentious topics remaining in pension planning is the 'age 75' issue and the perceived problem of compulsory annuity purchase at this age.

I use the word 'perceived' because, in reality, the compulsion to buy an annuity ended at A-Day in 2006 with the introduction of alternatively secured pension (ASP).

This point seems to have been missed by the Conservative party who, in October 2008, requested suspension of the rule that compelled annuity purchase.

Post A-Day the issue has concerned the draconian tax treatment of funds that remain on death while in ASP.

Many of the arguments for and against are well rehearsed and can be broken down to include:

- Why should there be any restrictions at all?

- If there are to be restrictions, why at age 75?

- Is there a pragmatic approach that can be taken that might satisfy all parties and, if so, is it likely to change?

The Government, through both HM Treasury and HMRC, have always argued that a pension fund should be turned into a secure retirement income. In the Annuities Market Paper, published by the Treasury in 2006, this was referred to as the 'annuities deal' and it was confirmed that: "... this longstanding requirement dates back to the 1920s."

HM Treasury gives large amounts of tax relief on pensions: income tax on contributions, freedom from tax on investment growth and a proportion of the benefit as tax free cash. So, in return for this, HM Treasury wants some tax back and they do not want individuals to fall back on state benefits.

How wide is the definition of 'secure retirement income'? For the purpose of the paper in question, it appears that only an annuity meets this definition.

So, HM Treasury requires that pension funds must be turned into a stream of income and therefore tax, and somewhere in the mists of time, the magic age of 75 was set as the final date that annuity conversion should take place.

With poor annuity rates and a growing awareness of investment and inheritability, many investors argue that their pension fund is effectively their own cash (with the addition of the tax relief) and that, because of this, they should have the freedom to take their pension income in a way that suits them, even allowing them to leave some as an inheritance for their children.

Until the introduction of income drawdown in 1995 there was no real other option than annuity purchase. The introduction of income drawdown did not abolish annuity purchase, just deferred it until age 75.

At A-Day, the compulsion to buy an annuity at age 75 was finally abolished and the concept of ASP was born. For a few short months we had a regime where it appeared that any surplus on death could be efficiently cascaded down the generations until the rules were changed in the pre-Budget report of 2006 effectively introducing an 82% tax charge on the death benefit.

Why age 75?

Times have changed and, as we know, we are all living longer and therefore any relevance that age 75 had, would appear to have been superseded.

When income drawdown commenced in 1995, one of the most relevant issues was the mortality cross subsidy enjoyed by annuities, in that those that lived longer benefited from those that died before their actuarial life expectancy.

It appears that with the increases in longevity this is changing and that there is no real mortality cross subsidy until, say, age 68-70. This means that more people will probably go into drawdown, at least to start with, as there is no extra value perceived in buying an annuity.

The perception of annuities

Annuities have a number of advantages and disadvantages.

The two main objections to annuities are the fear of dying before having received back an amount equivalent to the fund (any surplus returning to the insurance company and depending on any dependents' benefits selected) and the fact that the perceived investment return is poor when compared to the alternatives.

I think that this is missing the point of annuities and that instead of being regarded as an investment, they should be considered as insurance, i.e. insurance against living too long, in that the annuity provider will pay the annuity for life, however long the annuitant lives. Therefore, an annuity becomes better value the later it is purchased.

The future

So, how do we go about reconciling the position of HM Treasury with the demands for reform?

Well, the logical change would be to reduce the 82% tax - but to what? A degree of discussion would need to take place to come up with a tax rate that is suitable to both camps. A rate of 55% has been suggested, to be taken straight from the scheme, with the residue being payable only to the beneficiaries' pension scheme (allowing future tax to be taken when it is turned into a stream of income and tax relief to be saved against that individual's lifetime allowance).

As we know, it is currently in legislation that, in 2010, the minimum age at which a pension can be drawn will be increased from 50 to 55. Surely, it would be very easy to build on to this an increase from age 75 to 80 as the age at which the ASP regime applies. This could be a holding measure pending a full investigation.

There are a number of other factors to consider.

The Conservative party has indicated that if they won the next election it would change the rules at age 75, but we are not yet clear exactly how. There has been some mention of the work done by the Retirement Income Working Party some years ago, which proposed the securing of a level of income that would prevent eligibility for state benefits with flexibility attached to any excess.

One firm of lawyers has suggested they will be taking the Government to the European Court on the basis of the alleged age discrimination of the ASP regime but, with an election perhaps not far into the future, is this realistic?

However the one issue that I think overrides all of this is that it is always perceived as being a policy change designed to benefit the 'well off'.

For most people an annuity will be the most suitable way of securing a retirement income and, in all probability, the majority of people who start off by going into drawdown will buy an annuity before the age of 75.

So, the number of people over 75 who could potentially enjoy any post-75 regime will be relatively few, therefore, politically, there are few votes to win.

Even then, the perception is that the only reason that anyone would continue an investment portfolio beyond the age of 75 is for the tax efficient inheritance of the pension fund by beneficiaries and, as I have previously mentioned, this is anathema to HM Treasury, which has provided the individual tax relief.

Some sort of consensus is needed and I think that each side needs to give a bit of ground. We must recognise where HM Treasury comes from in their need to recoup the tax incentives that they give, but I would also like to think that HM Treasury could be pragmatic in this arena allowing a solution that would suit all parties. There may only be a limited number of people that will carry on planning after 75 but many more people will aspire to and as a consequence might pay higher pension contributions.

With the 'baby boomer' generation coming up to retirement and the forecast of record amounts of money emerging into the retirement planning arena this is an important decision to get right.