Annuity providers gone 'awol'
One factor that could slow the development of DC plans on the Channel Islands is the shortage of annuity providers.
Under current legislation, as in the UK, Jersey and Guernsey residents must use the bulk of their pension pot to buy an annuity. As in the UK, these have fallen in value. Typically, annuity rates are less than two-thirds of what they were 10 years ago.
However, they face the added problem of finding someone who will sell them than annuity. Currently, there is an acute shortage of annuity providers who are active in the local market. Until a few years ago, there was a choice of three providers: Equitable Life, CGU and Norwich Union. Equitable Life has now ceased writing new business and CGU has merged with Norwich Union.
Few insurers are willing to enter the market, although Guernsey-based insurer Generali has said that it is prepared to provide annuities if the scheme is large enough. One of the reasons for this reluctance on Guernsey is the island’s system of taxation – in particular the Employee’s Tax Instalment scheme (ETI) introduced in 1980. The ETI is an instalment scheme for deducting tax from anyone receiving wages, salaries, or pensions from an employers in Guernsey. Specifically it is applied to annuities from retirement annuity contracts.
The objection to ETI is that it is specific to Guernsey, and therefore disliked by the large international insurers. Guernsey’s Pensions Advisory Panel has no doubt that the Income Tax Authority application of the ETI scheme to annuities is the main reason for the lack of local annuity providers
The panel has warned that this could cause problems in the future: “The fact that very few insurance companies are prepared to write this type of business means that in an extreme case, a scheme’s winding up could be delayed or frustrated if quotations are not available,” it reported.
Guernsey residents have an option to provide the annuity in Retirement Annuity Trust Schemes (RATS). RATS are trust arrangements which act effectively as individual pension schemes and are available to anyone living in Guernsey. They can be used in group schemes and in this respect are similar to group personal pensions (GPP) in the UK. The Pensions Advisory Panel has proposed that group RATS should be treated in the same way as occupational DC schemes under the proposed new regulations for pension funds.
Under a RATS arrangement, individuals have considerable freedom to invest their fund. There is no limit to investment in listed companies, although private equity investment is limited to 10% of the total fund. Paul Buckle, pensions expert and a solicitor with Carey Olsen in Guernsey says: “The big attraction of these schemes is that there is no need to purchase an insurance company annuity at retirement. Instead the annuity may be paid from the fund itself. The amount of the annuity will depend on investment performance, and hence, well invested funds may result in a higher pension than would have been available under an insurance company annuity.”
The freedom to invest and the need to employ an investment manager, means that only wealthier individuals with substantial assets are likely to take this option. In the past there have been concerns that RATS have been mis-sold to people for whom they are unsuitable. In response to this the Income Tax Authority and the Guernsey Financial Services Commission (GFSC) issued a informal code of practice. The GFSC also regulates insurance intermediaries. However, the government-appointed Pensions Advisory Panel is currently seeking views on whether further regulation of RATS is necessary.
Whatever the concerns, RATS have impressed the UK’s Association of Private Client Investment Managers and Stockbrokers (APCIMS). The association, which represents the wealth management industry, has suggested that the UK government should seriously consider allowing a similar model to be used in the UK with criteria and taxation set appropriate to the UK environment.
Meanwhile, Jersey has provided its own solution to the annuity shortage. This year it amended its tax legislation to provide a drawdown option for Jersey residents, following the recommendations of a Retirement Options Working Group
Under the new drawdown scheme, people can transfer their accrued funds in an approved pension scheme to a drawdown contract as an alternative to buying an annuity and taking a lump sum.
To be eligible individuals must be members of an approved pension plan and must have reached the earliest age at which the pension payable out of those savings could have been paid under the rules of that scheme - usually 50. People who choose drawdown must give up any right to receive a lump sum.
Permitted investments are limited to cash with banks or building societies, securities and financial instruments traded on a recognised stock exchange, units in collective investment funds and long term insurance contracts.
The investment income earned by the funds will be free of income tax within the approved drawdown contract. There is no minimum or maximum amount that must be withdrawn in any year but everything withdrawn will be taxable. Any funds left unused on the death of the pensioner will be distributed to his estate and charged to income tax.
To ensure that people do not squander their savings and then fall back on state provision, they will have to show that they have from other sources, a guaranteed lifetime income of not less than the prescribed amount of Minimum Retirement Income (MRI). The MRI is an amount equal to the maximum old age pension payable by the States of Jersey to a single person with a full contribution record , currently £6,994 a year
The source of MRI must be something which is guaranteed payable for the life of the pensioner and is guaranteed to increase by at least 3% per year.
The Jersey tax authority emphasises that this option does not undercut the traditional annuity system. "There is now a greater choice, but there is no compulsion. No-one who wishes to remain in his existing arrangements will be forced to change,” it says.
Drawdown, like RATS, will not suit everyone, the Jersey Financial Services Commission says. The commission has issued a code of practice which points out that drawdown products are complicated products and generally suitable only for a sophisticated investor.