Whether to take it or leave it
If the current low interest rate, low growth environment persists across Europe the question of annuities is likely become contentious. The value of annuities – which is linked to the performance of bonds – has fallen with interest rates. As defined contribution (DC) pension plans mature, people are discovering that they will receive less than they expected.
Most people who are not members of defined benefit (DB) schemes are obliged to turn their pension contributions ‘pot’ into a regular income by buying an annuity for life from an insurance company or similar provider. In the UK, for example, this is a long-standing condition for defined contribution pension schemes which then qualify for favourable tax treatment.
But now people are beginning to argue that they should be free to withdraw their accumulated contributions as a lump sum rather than be forced to annuitise them.
The argument against allowing people to take lump sums is that, if pensioners were able to draw all their personal pension funds, they might find themselves forced to rely on state benefits later in retirement – precisely what tax relief on pension contributions is designed to avoid.
In countries where it is possible for people to use up their pension funds during retirement in this way, this effect is called ‘double dipping’ and has been criticised as unfair to other taxpayers.
There is also a view in the financial services industry that ordinary people do not have the investment skills to run their own money – to become, in effect, their own pension manager.
In this month’s Off The Record, we find out what you think about the subject of annuities and capital withdrawal, particularly as regards to what happens in your own countries. Clearly in some European countries annuities are not a matter of choice. In The Netherlands, for example annuities are the only option, except for small amounts). However, many of you feel able to express an opinion generally.
Most of you (72%) feel that
people should be free to decide what to do with their accumulated pension contributions when they retire. One manager of a Swedish fund sums up the general feeling: “It is not fair not to give people the possibility of choosing what to do with the benefits they have earned during a working life.”
This is reflected in the mixed response to the requirement in some countries that pensioners surrender their accumulated capital for an annuity. A substantial minority (45%) feel that this is unfair.
However, some feel that allowing people to take a lump sum rather than buy an annuity misses the point of a pension. One manager of pension funds in
Portugal makes the point that “a pension is the income that will support you for the last years of your life. If a pensioner has other sources of income, he should convert those other sources into capital and not the pension.”
Some also feel that people should be allowed to take some but not all of a pension ‘pot’ as an annuity. “It need not be 100%, but in order not to burden the state there must be a requirement for some minimum annuity,” one UK pension fund manager suggests. “There should be a minimum that is taken as an annuity to avoid poverty,” another manager says.
There is also a feeling that people cannot be trusted to invest a lump sum wisely. “To a certain extent people have to be protected against themselves,” the manager of a Dutch pension fund suggests. “People are not used to their own asset management for pensions,” a pension fund manager in Germany says.
The message seems to be that pensioners should leave the investment of their assets to the professionals. “In general, it is better and cheaper that a pension fund is taking care of the investment management and guarantees the indexation,” says the manager of a Dutch fund.
So, should people be able to take all or any of their pensions ‘pot’ as a capital lump sum? Almost one in three (62%) think that people should be allowed to take their pensions pot as a lump and large majority (90%) say they should be allowed to take a percentage of it. More than half of these say this can be up to 100%. About a third say up to 50%. The remainder suggest maximum amounts of 75%, 33% and 20%.
However, over a third disagree with the principle of swapping a pension pot for a lump sum. The main objection is that people will squander it. “There is a risk that the lump sum is spent too quickly and no more is available,” says one Luxembourg-based manager.
But there is also a more fundamental objection – that society has a responsibility to see that people are properly provided for in retirement. “A pension should be seen as a postponed income which is necessary to complement the government pension. We should not put the investment risk and longevity risk on the shoulder of the individual,” says the manager of a Belgian pension fund. “We should, first of all, see that the annuity, together with the state pension, is enough to have a decent life. Anything above that can be paid out as a lump sum.”
Should people be required to buy an annuity by a certain age – say, 75? This requirement gets little approval. More than four out of five (83%) of you feel that there should be no such obligation.
If people are allowed to take a lump sum instead of buying an annuity, should the tax authorities be entitled to claw back some of the tax relief on contributions, by imposing an exit tax on any extracted capital? A small majority (59%) agree with this suggestion: “Contributions should be tax deductible. Extracted capital should be taxed as income,” is the view of one pension fund manager in the Netherlands.
Most (79%) think that people within European DC schemes should have options other than annuities when they retire. Some see a lump sum as the best option, since it opens the door to others. “The option should be to take their pension as a lump sum and they would be free to reinvest,” the manager of a Swedish pension fund suggests.
Other alternatives included portfolio transfer, reinvestment of capital, and income drawdown. One UK pension fund manager suggests that an option should be payment to relatives to provide housing – a recognition of the growing problem of providing long-term care for the elderly.
Whether there is any pressure to keep or change the annuity system will depend on whether people understand what they are buying. Here the evidence is alarming. A clear majority of you (56%) think that most people do not understand how annuities work. Only a third (34%) believe that people understand annuities.
Whose fault this is is not so clear. We asked you whose responsibility it was to educate the public about annuities – the government, the pension plan sponsors or employers, the pension plan providers,
the annuity providers or people themselves. Few of you (16%) see annuities as any business of the government. Most lay responsibility at the door of the pension plan providers (80%), followed by the plan sponsor (74%) the annuity providers (63%) and people themselves (58%). One manager says that responsibility for finding out about annuities must rest “mainly” with individuals.
Much will depend on the choices of annuity that are available.
So, finally, we asked whether you thought a cross-border market in annuities would be helpful. Most of you (79%) think it will be beneficial, with 7% unsure and only 14% doubtful. Clearly, if annuities are to continue as the dominant form of pension pay-back, anything that allows people to choose from a wider range of annuity products is welcome.