Pension freedom saved millions from locking into poor annuity deals

Ros Altmann: Around half a million people each year were at risk of having to buy annuities – but were thankfully spared

Ros Altmann is a former Pensions Minister who campaigns on behalf of the elderly, and sits in the House of Lords.

Pension freedom gave over-55s greater power over how they spend, save or invest their retirement pots.

Baroness Altmann explains how many were freed from buying an annuity when deals hit rock bottom, and why pensions should be shaken up again to better serve savers’ needs now.

Pension freedom reforms have saved millions of pensioners from locking into record low annuity rates, without protection against inflation or any income for spouses that outlive them.

Many of those people who took advantage of the changes introduced in 2015 have been spared the need to buy annuities at rates that would have left them poorer for the rest of their lives.

Around half a million people each year were at risk of having to annuitise, against the background of ongoing Bank of England ‘money printing’ – quantitative easing – policies that deliberately drove down long-term interest rates.

As those rates fall, annuity costs rise and deals worsen, and so pensioners swapping their pension pot for a lifetime income receive much less for ever.

Before April 2015, pension firms were permitted to require their customers to buy an annuity with their pension fund to provide a retirement income.

The invest-and-drawdown plans that are freely available now, and allow people to pass on hard-earned pension savings to their loved ones rather than being swallowed up by insurers when they die, were subject to relatively inflexible restrictions back then.

Unless people had a very small or very large fund they were forced to annuitise, and the majority received no proper customer help.

There was no transparency on the risk margins or profit margins that insurers were pricing into the products, so that people were stuck with a lifetime income that may have resulted in them losing their capital if they died within a few years, would never rise with inflation and offered nothing to a surviving partner.

People were told to ‘shop around for the best rate’, but this generally just led to them finding a ‘single life, level annuity’ – single life meaning nothing for a spouse that outlived you, and level meaning no inflation protection.

This gave people a better rate, but often for the wrong product, rather than helping them make the most of their pension savings.

Pension freedoms have been brilliant for many of Britain’s pensioners, who stayed invested and avoided getting locked into poor annuity rates, says Ros Altmann

There has been a great deal of criticism of pension freedoms, but they have been brilliant for many of Britain’s pensioners during a time when annuity rates plummeted as a result of central bank policies.

Now that the Bank of England’s quantitative easing programme is coming to an end, the outlook for both interest rates and annuities has changed.

Recent rate rises have led to a recovery in annuity rates, which have risen by about 20 per cent over the past year.

This might prove advantageous to those giving annuities another look now, but people who locked in to annuities at old lower rates will not benefit. They cannot reverse or vary the terms of their original annuity purchase.

But at least the many people who took the opportunity to use pension freedoms instead of buying an annuity got the chance to keep their money invested, and benefit from investment returns to help offset inflation rises.

Those people have had the chance to build a better pension fund in recent years.

They have been in a position to wait longer before locking into an inflexible income stream from an annuity for the rest of their life, and benefit from rising interest rates now.

If their health has deteriorated, they are also better placed to receive higher lifetime pensions from an impaired life annuity, that better reflects their likely life expectancy.

New thinking is needed to overhaul ‘default funds’ too

UK pensions are still ripe for new thinking, which moves away from one-size-fits-all ‘default funds’ which most people stay in while still in work and saving for old age.

Many people in auto-enrolment pensions who are close to retirement have been badly let down by their lifestyle or target date ‘default funds’, which wrongly switched them in recent years away from equities and higher potential return assets into supposedly low-risk bonds.

Without asking members’ retirement intentions, their money was just automatically moved into ‘safe’ bonds, which plummeted in price as inflation rose and quantitative easing ended.

This approach aimed to ensure the scheme member was not exposed to huge falls in their pension assets just before retirement.

But many of these products, relied on by millions of UK workers and investors, had not been redesigned to reflect pension freedoms brought in eight years ago.

There was no check on whether the pension scheme member was actually intending to retire at the ‘target date’.

And, crucially, they were still based on the expectation that people would buy an annuity, rather than keeping money invested in retirement.

Even as it became clearer that inflation was rising and interest rates would have to increase, most of these funds kept switching people’s investments into bonds.

Sadly, the experience since 2022 has been disastrous, with many of these funds losing 20-30 per cent of their value as yields rose on UK government bonds – known as gilts – and their prices collapsed.

During 2022, gilts lost 20 per cent and index-linked gilts more than 30 per cent, while the FTSE All Share and FTSE 100 rose 1 per cent (or 4.7 per cent including dividends).

Yes, the FTSE 250 smaller companies index fell nearly 20 per cent, but overall the supposedly lowest risk bond asset class proved riskier than ever imagined.

The post-quantitative easing world is unprecedented. Nobody knows how the unwinding of central bank bond purchases will play out.

Many people are no longer planning to annuitise at any particular age, they may keep working longer and their health may deteriorate.

That is why we need innovative thinking on how savers can benefit from long-term pension investing that does not assume any particular age at which money will be withdrawn, and would ask people each year whether they had particular plans for their pension fund.

This would allow new approaches to income drawdown, individualised annuitisation at later ages, continuing to invest long past state pension age, and guidance or advice for later life financial planning.

One approach could be dividing a pension fund into four parts, with perhaps the tax-free cash for people in their 60s, then the remaining parts invested for their 70s, 80s and 90s – taking a longer view of investments.

Individual pensions that recognise each member’s circumstances and needs are required. It’s time to rethink pensions for the modern world.

This post first appeared on Dailymail.co.uk