§ 7.51 p.m.
§ Baroness Dean of Thornton-le-Fylde
rose to ask Her Majesty's Government when they will take steps to end the present mandatory requirement on personal pension fund holders to purchase an annuity at the age of 75.
The noble Baroness said: My Lords, first I thank the small band of noble Lords who are to take part in this short debate tonight, particularly my noble friend the Minister. I am sure that at the end of the proceedings on the Welfare Reform and Pensions Bill my noble friend believed that he had seen the back of the issue of annuities for some time to come. I note that the noble Lord, Lord Higgins, has escaped tonight and that his place is taken by his noble friend Lord Astor of Hever. On 11th October the noble Lord, Lord Higgins, tabled an amendment to that part of the Bill concerned with stakeholder pensions. It called for the removal from the Bill of the requirement to buy an annuity related to a stakeholder pension. If noble Lords look at col. 65 of Hansard for that day, they will see that I went into the Division Lobby in opposition to that amendment.
It may assist if I make clear at the outset what my Question does not seek to do. I do not favour the abolition of the mandatory requirement to buy an annuity related to a pension; nor do I seek to increase the age at which a person is required to start taking income from a pension fund, which is 75. In the context of my Question I propose that the age be increased from 75. I did not specify an upper age, but I propose that it be 80. Therefore, at the age of 75 a person holding a pension fund would be required to start drawing down taxed income from the fund but would not be required to convert the fund into an annuity until the age of 80.
890 I believe that it was in the 1950s that the age was increased to 75. In those days there were far fewer people covered by pension schemes. Certainly, no one was covered by some of the schemes that we have today. Most were covered by occupational schemes, although it was a smaller number than today. Most of those pensions would have been defined benefit schemes which, by and large, would not be caught by this provision.
The Association of Insurance Brokers tells us that this year about £10 billion will mature for draw-down or conversion to annuities. There is a view in the industry that in 10 years' time that figure will have risen to £50 billion. We are talking about the investment of a substantial amount of money in a way that does not deny to the Chancellor the right to income tax from the benefits but also allows for the investment for which the person has saved all his life to give a decent return. Herein lies the core of my concerns. Interest earned from annuities has halved in the past decade and that accounts for a considerable amount of money. That is because the returns from gilts have been reduced.
I do not believe that my Question this evening in any way runs counter to or dilutes the national policy of this Government, and previous ones, to try to encourage people to save for their retirement. Having benefited from tax allowances, at the time of their retirement they should not try to manipulate the money that is available in a way that takes unfair advantage of the tax breaks that they have received.
I have looked at the situation today. I do not know what the Minister will say this evening. It may be said that there are a variety of methods and that people do not have to choose simply a fixed term annuity. For example, there is the draw-down option introduced in 1995. There is also the possibility of going for a fixed annuity whereby there is a guarantee of up to 10 years from the date of purchase. There is a joint annuity for couples. Having taken out the annuity, it ceases only at the point when both partners pass on.
It may be argued that there is flexibility. However, I suggest that there is a big price to pay for that small degree of flexibility. In the case of a variable annuity, in every case the costs are higher and the returns lower and the people whom they hit are not the wealthy. People have said that this is about helping the wealthy; it is not. The people most affected by the current situation are those on low incomes who find it difficult to accumulate pension funds of any substantial size. Of the various options to try to protect pension funds, they are the people who pay the highest charges in proportion to their schemes.
It may be argued that to take an annuity is almost like trying to win the lottery. It depends on the day when one assesses the fund that is to give a return for the rest of one's life irrespective of the health of the market. The events of the past decade in relation to gilts are not new. Those of us who have been involved in occupational pension schemes over the years have seen schemes in which the majority of funds have moved from gilts to equities. That has been a painful 891 process but as a result there are much healthier occupational pension schemes. However, this provision relating to annuities lags behind. Because those variable options cost more, the majority of people go for annuities only for themselves because they give the biggest return. If the individual passes on within a very short time of taking out the annuity, the consequence is that the whole fund reverts to the life company.
Pensions are complex and there are lots of anomalies, many of which cannot be resolved. Some argue that someone who smokes heavily and does not look after himself, and therefore has a shorter anticipated lifespan, under the current arrangements could take out an annuity and receive a better return than an individual who does not smoke and has looked after himself because he is assessed actuarially as having a longer life expectation. That seems crackers in anyone's book. Such anomalies are almost exaggerated by the straitjacket with regard to annuities.
I was shocked to learn that if, in a contractual annuity, the return exceeds the permitted maximum by more than 3 per cent, the Inland Revenue requires that the balance between the 3 per cent and whatever was achieved is reverted into the reserved with-profits funds of the life company. It is there to provide for under-performance. If there is no under-performance in the lifetime of the pension holder, the sum being held reverts to the life company as a windfall profit. I find that difficult to accept. That anomaly may be part of the fall-out from the requirements of the pensions legislation.
I tabled the Unstarred Question out of concern for low income people, and the increasing number who have personal pensions, as we have all been encouraged to do. The debate is not about the large funds of the wealthy. A large fund is not affected in the same way as is the present annuity system.
I support the principle of encouraging people to save for retirement. It is not a new interest; I have done so all my working life. There was a provision that if your company had an occupational scheme you were required under your contract of employment to join that scheme. I believe that the removal of that requirement was a retrograde step.
The Government have made progress in introducing stakeholder pensions. The concept is good. I am sure many people will join stakeholder pensions. However, there is a view—I support it—that without changes in the present annuity provision which allow greater flexibility, and allow the pension fundholder to be a customer in the truest sense of having choice, the take-up will not be as great as one might have expected.
I know enough about pensions to realise that every proposal for change presents a problem. There is perhaps difficulty about the funding. Nevertheless, a range of ideas should be considered. A range of ideas has been tried elsewhere. Some may choose Ireland as an example. I do not. It is too soon to use the scheme in Northern Ireland as an example. However, there are 892 schemes in the United States. A scheme in South Africa has been running for some years and has proved effective.
§ Lord Astor of Hever
My Lords, the noble Baroness mentioned Ireland and then referred to Northern Ireland. To which was she referring?
§ Baroness Dean of Thornton-le-Fylde
My Lords, I thank the noble Lord for that intervention, giving me the opportunity to correct what I said. I referred to Ireland, where a £50,000 minimum is required.
I can understand the Treasury's concern about the loss of income from tax. One could say that, if one delays the annuity until 80 years of age, as I seek—only that is not enough; one needs to consider the whole reform—and starts to draw down at 75, if one passes on before 80 the Treasury could have a call on the balance of the existing fund at that time. Equally, I would argue that inheritance tax should take care of that aspect.
One could look at fixed term annuities, to be reassessed actuarially at the end of that fixed term. One could remove the requirement—new regulations would be necessary—that the annuity should be non-commutable and provide that one should be able to go back and do that against certain criteria. There may well be pitfalls. I do not put those suggestions forward as a panacea. But a review is necessary.
There are only about four kinds of product available at present. If we are to have a community which is saving for retirement—small though the amounts that individuals can afford may be—they need to have proper advice and proper choice as a consumer.
The Government have demonstrated recently that they are on the side of the consumer as regards the fixed interest mortgage issue. One had agreements reached between the consumer and the company. The Government have said that that is not fair in the interests of the consumer. We now need the Government to adopt that kind of consumer concern. I think that I am right—the Minister will correct if I am not—that the Government are considering the drawdown issue. I hope that they are looking at the maximum age limit of 75. I am aware that there was a parliamentary Question in another place. I am equally aware that the Minister replied that the Government would come back to the issue in due course. Perhaps the Minister can indicate how long "due course" means.
Some of us have been negotiating for many years for people's future provision. Pensions are savings. They are part of a person's income. They are part of a person's earnings. It is a wide issue. It not about avoiding tax. It is not about providing pitfalls for people who want to avoid the commitments into which they have entered. It is about giving people a choice, and ensuring that when they enter into agreements they get a fair return.
893 I shall appreciate answers from the Minister to the questions that I have asked today.
§ 8.6 p.m.
§ Lord Willoughby de Broke
My Lords, I am grateful to the noble Baroness, Lady Dean, for raising the question of pensions, especially as she is so clearly a long way off from being a pensioner herself. However, I was somewhat disappointed to hear her say that she does not seek to eliminate the need to take up an annuity. That is exactly what I think we should be discussing tonight.
I declare an interest. I am exhibit A! I am a pensioner; and I am a cross old pensioner too. I receive a very small taxed income from the annuity which I have taken out. Now that I have taken out the annuity, three-quarters of the money that I have saved over 35 years belongs to the pension company. It does not belong to me, my heirs or my estate. It belongs to the pension company. I think that that is unfair and inequitable. It is true that I could have delayed taking the annuity until I was 75—even, under the noble Baroness's suggestion, until I was 80. By that time I shall probably be too gaga to care what I do with it. However, if, having taken my annuity, on my 75th birthday I take my celebratory cruise and have a heart attack during a particularly vigorous game of deck quoits, again three-quarters of my enhanced fund goes immediately to the pension company. It is extraordinary.
The situation is rather like those men who try to sell you tarmac. If someone came to your door and said, "Now, squire, I've got a very good offer here. You'll absolutely love it. You give me nearly all your life savings and I'll give you a small income until you die", you might be a little upset and set the dog on him. It is exactly the same situation; there is no difference.
Something more imaginative is required from the Government. I am surprised that the noble Baroness did not go some way towards meeting that need. For example, the PEP scheme was excellent. It has been replaced by the slightly less excellent and more complex ISA. But when one puts money into a PEP scheme it is out of taxed income. The Treasury wants its slice and gets it because all contributions to PEPs or ISAs are from taxed income. The Treasury has had its tax. But one then builds up a tax-free fund. It is free of capital gains tax and of income tax. A retirement fund into which one can pay all one's life—it is up to the Government to state a minimum time before qualifying—would at least allow people to save and to keep that.
The noble Baroness is right to say that the issue is vital because it is about people's incomes; but it is also their capital. Under the present arrangement, three-quarters of it is given away to the pension company. It is that to which I object and I am sorry that the noble Baroness did not go further in her comments.
The Government may well be concerned that people who are receiving tax-free gains will spend it on riotous living, slow horses or fast women. But that would not 894 be the case because people are more financially aware. We are continually lectured about making provision for our old age. Every newspaper carries a financial section; there are financial programmes on radio and television; there is even a 24-hour financial service on television; and the Internet is full of financial advice. People are more financially aware than they ever have been and the Government's concern that "pensioner prodigals" will spend all their money and then throw themselves on the mercy of the state is without foundation.
It would make more sense if people, having saved all their lives, were allowed to keep their pension pot and dispose of it as they wish; whether on buying high interest coupons, low interest stocks, a property to let or whatever. They would be spending their own money; money which they had saved all their working lives.
That is the important point I wish to make. The Government will get their money early when people contribute to the scheme and those who have contributed to the scheme will have their own capital. The only losers will be the pension companies. My Lords, how very sad!
§ 8.12 p.m.
§ Lord Brooke of Alverthorpe
My Lords, I am grateful to my noble friend Lady Dean for tabling this Unstarred Question. I was present for the debates on the stakeholder pension funds on 24th June and 11th October and I voted against the amendment proposed by the Opposition on that latter date. Those debates were strictly within the confines of stakeholder pensions, but we are having a different debate today.
I regret that I must advise the noble Lord, Lord Willoughby de Broke, that I am not here to speak strongly for the total abolition of annuities I intend to speak on similar lines to my noble friend. It is an important topic and it is useful to have a general debate rather than the confrontational exchange which took place on 24th June and 11th October. There will be a commonality of view in some areas and I hope that from the Minister we shall gain an understanding of how we might move forward. Having read his firm response on 11th October—he nods—I hope that he will not be so firm tonight.
We must take note of what is happening around us because pension provision affects many people. The 1995 figures indicate that under existing pension arrangements at least 5 million individuals will have to purchase annuities. Moreover, with the shift from defined benefit occupational pension schemes to money purchase schemes—that is happening to many employees—the number is likely to grow.
The Government should take note of the fact that the simmering discontent with the present means of providing retirement income through annuities will grow. I hope that the Government will be conscious of that. Indeed, it continues to be one of the topics which figures regularly in the money pages of the financial press—and, in my view, with increasing justification. I speak not on behalf of the rich, but on behalf of 895 many people who continue to have to work long and hard to try to build up reasonable pensions in order to have a reasonable standard of life in retirement.
Therefore, I hope that the Government will listen carefully to the case not for total abolition but for change. I also hope that they will avoid the bureaucratic knee-jerk reaction which can come from government departments, particularly the Inland Revenue with which I have had a long association. They do not always react in such a fashion, but I imagine that as regards this topic they may believe that there is special pleading for a minority, that few people are affected by it, and that those who are probably well heeled and seeking to enhance their opportunities for further tax breaks. Like my noble friend Lady Dean, I contend that that is not the case or the purpose behind our argument.
I understand and appreciate the Government's caution about introducing changes. That was expressed by my noble friend. Even with the present declining rates, annuities give certainties, which is important. They provide a level of security for pension income that is a reassurance not only for the recipient, but also for governments, especially after they have provided tax relief for the contributions made during the years.
Annuities also help to limit dependency on the state, for which all governments aim in the longer term. I strongly argue that those factors need to be taken into account and be part of any annuity changes. I want to subscribe to such principles and I believe that the Government will continue to do so. We need to write them into future changes.
The Government also need to take account of the changes which have taken place in society during the relatively short time since the 1986 Social Security Act and the introduction of personal pension plans in 1988; for example, longevity has significantly increased. People are receiving better healthcare and better food. They take more exercise and are staying fitter. Fewer than 10 years ago, a 65 year-old man could expect to live until he was 79 and a woman until she was 83. Today, a man of 65 will probably live until he is 85, if not 87, and a woman until she is 87. A big change has taken place, therefore.
Furthermore, people are working differently from what was the fashion in the 1960s and 1970s; for example, there are now 4 million self-employed people as against only 1.5 million in the early 1980s. The Inland Revenue forecasts at least 5 million in self-employment soon. As IT spreads, we shall see more people working in different ways; working from home, for themselves or on a contractual basis.
Importantly, many people need to work longer, not just into their 70s but into their 80s, too. The demography of the future labour force will require more people to work even longer. The Government will need that. People will not only be fit enough to work, but I suspect that many people will want to do so. Furthermore, a substantial number of people will have divorced perhaps twice and married a third time and will have seen their pension provisions scattered in 896 a number of different directions. They will need to continue working to try to build up a reasonable pension because they will perhaps not have access to those to which they contributed earlier. There is a case for looking at how we can give support to those people. They will want to continue making contributions towards building good pensions which will provide a reasonable standard of living in retirement and for care in old age—for which, again, the Government are changing the provisions.
In the immediate future I can see no reason why the current legislative requirement for money purchase pension holders to purchase an annuity no later than age 75 should not be reviewed and be increased to, say, age 80. The age of 75 has been the upper limit for many years. I do not know from where it was plucked in the first instance, but it was certainly stipulated in the 1986 legislation and when pension plans were introduced in 1988. On an index link to the changes in longevity, looking at a period from the last decade to this one, there is at least a case that it should be reviewed and revised upwards. I am not certain how far it should go, but we should have a serious look at extending it up to the age of 80.
The principal advantage of such a change is that not only will people be able to make contributions for a longer period but they will also be able to purchase their annuity at the time which would be to their best advantage. Furthermore, if the existing income draw-down provisions were applicable between the ages of 75 and 80, that would be beneficial also—not to many people, but it would provide some benefit. I should like to hear whether my noble friend the Minister is prepared to give, in the light of the arguments which we have been advancing, some more favourable consideration to possible changes. That might possibly even include indexation of the age limit as a factor to be examined. Again I see him scowling, as if to say, "No, I am not prepared to do so", but those are issues that we should look at carefully and not dismiss lightly. If we do so, we are ignoring changes which are taking place around us.
It may be feared that those are tax-aided arrangements which could accrue lump sums or savings rather than pension schemes. I am conscious of that and I do not want to see that happen either. There are many anomalies and loopholes in the inheritance tax legislation which would not cover some problems that could arise on that front. I suggest that those can be plugged. Indeed, I urge the Government to start turning their attention to inheritance tax reform and reorganisation. However, those factors should not be a reason for not looking for more flexible applications of annuities to provide opportunities for better returns, yet with safeguards to meet the Government's aims that I mentioned earlier.
We need to stimulate a more imaginative and innovative response from the life insurance industry than we have had so far in its offerings to its customers. I suggest that if any life insurance people listen to this debate or read it in Hansard afterwards, they should start to pay attention—as are some of the banks—to people's other greatest asset next to pension plans; 897 I refer to their homes, their houses. Is it not time to start thinking about making a link between the two so that pensioners might be able to look forward to more flexible annuities with more flexible overall packages which provide for an even better income stream in retirement and would, in particular, enable them also to have good care in old age?
§ 8.24 p.m.
§ Lord Taverne
My Lords, I begin by declaring not one interest, but two. First, I am chairman of an insurance company, Axa Equity and Law Life. Secondly, I have a personal interest, because at the age of 75 I shall be forced to have a fixed annuity which I should much rather avoid. From the point of view of personal interest, I greatly hope that the suggestion made by the noble Baroness is followed by the Government.
However, I shall consider the issue not from a personal point of view, nor indeed, from a corporate point of view. I begin with what appears to be the suggestion in the Unstarred Question—although I gather that the noble Baroness gave a different interpretation to it—that we should, in effect, abolish the present mandatory requirements.
On the face of it, the Motion seems very reasonable. Of course, what the noble Baroness said was very reasonable, as one should expect. A fixed date can undoubtedly be difficult. Interest rates may rise rapidly and unpredictably. I defy people to predict the future of interest rates. Economists are extremely good at telling one tomorrow why what they predicted yesterday did not come true today. Interest rates can rise and fall unpredictably. A great difference can be shown by a matter of timing, even within a period of six months. There is an element of a lottery, as the noble Baroness pointed out, which can certainly seem extremely unfair.
However, I have considerable difficulty with the Motion and I may even have some difficulty with the interpretation given to it by the noble Baroness. I turn first to the Motion. The fundamental question is why tax relief is given to pensions. The simple reason for that is because the state has a considerable interest in people providing pensions for themselves. Therefore, it encourages tax relief and savings. The tax relief for pensions is extremely valuable. It has the classic EET form: there is exemption for the contributions, exemption for the income as capital, and tax for what comes out.
The tax-free lump sum is an anomaly in that, and has been so for a long time. At some stage, I expect that the Chancellor will have a go at that tax-free lump sum. It is kept because many people have made their plans on the basis of receiving such a sum and it therefore seemed harsh to deprive them of that.
There are two advantages if there is a postponement of the age at which the annuity—which is the equivalent of a pension—has to be fixed. First, the capital continues to be available with tax-free income, from which a certain amount has to be drawn which is 898 of course taxable. Secondly, by postponing the annuity one receives a higher rate of annuity. However, if the mandatory requirement is abolished and people need not take out the equivalent of a pension at all and may then pass on the estate through inheritance, often avoiding inheritance tax, it seems to me that one is rather over-egging the pudding and providing a considerable advantage by way of tax relief.
Tax relief is a wonderful thing to have but one man's tax relief is another man's tax burden, and another woman's tax burden. One cannot be generous and give tax relief all round because other people still have to pay corresponding taxes. Therefore one has to examine whether, in some ways, tax relief can be over generous. One must compare pensions with other forms of savings. Because of the large contributions which can attract the exemptions, tax relief of that kind—if there is no liability at the end and further advantages are obtainable—is far greater than that which can be obtained by other forms of saving such as ISAs.
Therefore I believe that the Motion, if interpreted purely, would be stretched too far. Is 75 even such an intolerable age? The noble Lord, Lord Willoughby, says that the whole system of annuities is unfair because one may die the day after one takes one's annuity. He said that he might die on his cruise playing deck quoits. I should have thought it far more likely that, following the example of many in this House, he will live to a ripe old age and that it is the insurance company that will lose. For one person who dies and therefore gives a great benefit to the insurance company, another person lives to a very ripe old age and the insurance company loses, which balances out. If people live longer, then rates will be lower If people die earlier, then the annuities can be more generous and it will balance out.
§ Lord Willoughby de Broke
My Lords, the money that one has saved goes into the pension fund not just when one dies, but when one takes the annuity.
§ Lord Taverne
My Lords, of course, the money goes to the pension fund—in order to pay the annuity. That is the nature of the bargain.
It seems that it was right to extend the age beyond 65 because life expectancy is so much longer. People now have 10 more years to make a choice. During a period of 10 years it is likely that interest rates will go up and down. People may miss their chance when interest rates are high or they may be unlucky or badly advised. It is a lottery. I do not see how that can be avoided if a pension becomes fixed. The nature of defined contribution pensions is that the employee or the individual takes the risk. The great advantage of defined benefit pensions is that that risk is then taken by the employer.
Should the age limit be extended to 80? I have no dogmatic views on that. It seems to me that if one gets close to the age of life expectancy—as the noble Lord, Lord Brooke, pointed out, for those who have reached 899 the age of 65 that is still well above 80—the advantage of the annuity tax-relief system begins to edge too close to what is perhaps an exceptional advantage.
On the other hand, I believe that the question should be looked at again. Many of the suggestions made by the noble Baroness should be examined. As we live longer, I believe that from time to time the age limit will have to be raised. The other day a Dutch population expert predicted that babies born in the year 2010 will live to be 115. I hope that people will work longer. People are likely to be fit for much longer.
In my old age I have taken up running. The other day I read in a magazine about a highly competitive veteran athletic club where the over-60s held world championships and the 100 metres was won in a time faster than that of the Olympics of 1892. It is incredible how the physical abilities of people have changed.
On balance, looking at the tax advantage of the pension system, one should compare it with other forms of savings and the tax benefits that they give. On the whole, I am inclined to conclude that at the moment 75 is a reasonable age, but I am open-minded on the matter. I do not think that anyone should be dogmatic about it. As time goes on, I believe that the age limit will have to be raised.
§ 8.32 p.m.
§ Lord Astor of Hever
My Lords, the House is grateful to the noble Baroness, Lady Dean, for introducing this important debate. As one would expect from someone who was on the Occupational Pensions Board and who lists pensions as among her special interests, the noble Baroness speaks with great authority and clarity on the subject. I look forward to hearing the response from the Minister. I know that he has a great deal of personal experience in this area. The debate has been characterised by contributions from noble Lords who are also experts. As a pensioner, my noble friend Lord Willoughby de Broke spoke with great authority.
As the noble Baroness used the word "when" in her question and not "if", I hope that there is cause for optimism, although I understand that she seeks only to raise the age from 75 to 80. At Report stage of the Welfare Reform and Pensions Bill, the Minister told the House that the Government were monitoring the annuity position and that the Inland Revenue was conducting a special exercise to assess how the current arrangements on income drawdown and annuity purchase were working in practice. I also remember that the Minister assured the House at that time that Gordon Brown was able to walk on water. If the Chancellor can do that, surely he can resolve the problems associated with forcing personal pension fund holders to purchase an annuity at age 75!
On 30th June in a debate on pensions in the other place, the Minister of State, Stephen Timms, said that the Inland Revenue's review would be published in the autumn. Today being 1st December, by my reckoning autumn has been and gone and we are well into winter. Therefore, can the Minister tell the House when we may have the results of that important review? I hope that the answer will not be "in due course".
900 Recently annuities have been the subject of much focus. As I am sure the Minister will be aware, Members of Parliament on all sides are finding that many constituents approaching the age of 75 are unhappy about the requirement to purchase an annuity. Indeed, I am advised that surveys show that about 98 per cent of people approaching the age of 75 are unhappy about it. I agree with the noble Baroness, Lady Dean, that it is not just the rich who are affected but also people on low incomes. This is not just special pleading for minorities, as the noble Lord, Lord Brooke, said.
The steady fall in long-term interest rates is seriously reducing the value of pensioners' incomes in retirement derived from an annuity. According to the Financial Times, in the autumn of 1997 annuity rates were at their lowest level for 40 years. In the past 10 years annuity rates have fallen from around 16 per cent to 8 per cent, halving income that a newly retired person with the same lump sum would receive.
I assure the noble Lord, Lord Brooke, that I do not want to be confrontational, but on these Benches it is our clear view that the requirement to buy an annuity at the age of 75 should be abolished. Indeed, this campaign has been driven for some time by the Conservatives, particularly by my honourable friend the Member for Arundel and South Downs, Howard Flight.
We want individuals to exercise a greater degree of choice for themselves. We want greater flexibility to allow those who have saved into a fund more control over their hard-earned savings to enable them to take advantage of a broader range of investment solutions. From a public policy standpoint, the issue of annuities is important, not least because of the Government's desire to promote stakeholder pensions. That has already been touched on.
If the annuity rules relating to 75 year-olds were to stay as they currently are, I believe that professional best advice would suggest that many of the target market would be better served by putting their money into an ISA rather than into a stakeholder pension. Whether or not it was in fact the best professional advice, human nature would probably produce that result.
When viewed by those with perhaps less to save, the choice would be between a stakeholder pension and an ISA. With an ISA they could put money in when they chose to but withdraw it when they chose to. If they have the discipline to continue saving until their retirement, they could use the fund as they saw fit. With a stakeholder pension the choice will be to put money into a stakeholder pension as flexibly as with an ISA, to have that contribution grossed up for tax, but to be forced to leave the money there until they retire and then be forced to purchase an annuity with everything they have saved. Put in those stark terms, as many pensions experts do, it is likely that many will choose the ISA route rather than the stakeholder route.
901 In the light of that, does the Minister agree that compulsory annuities for all the moneys saved in a stakeholder pension scheme could damage the attraction of the scheme? If so, what action do the Government intend to take to redress the situation?
I draw the Minister's attention also to the range of more flexible arrangements such as equity-linked, variable drawdown and term annuities that are currently found in the United States, Australia, South Africa and Ireland. Though the noble Baroness may disagree, the Irish pension system is particularly interesting. Pensioners there buy a basic annuity and are then free to do as they like with the rest of their pension pot. Will the Minister consider looking at such arrangements to see whether they would have any merit in this country?
The problem facing those coming up to 75 is now serious. Government policy must respond. The issue will not go away, and Ministers in the other place accept that. I hope that the Minister will bring the House, and the many people approaching retirement age, some good news tonight.
§ 8.40 p.m.
§ Lord McIntosh of Haringey
My Lords, the noble Lord, Lord Taverne, said that there were considerable difficulties for economists in making the kind of forecasts necessary to understand these issues well. It is not just economists. I remind him that the solicitor of Jeanne Calment of Arles made a deal with her when she reached her 90th birthday. The deal was related to her flat in Arles—in French it is called viager—that while she lived, he would pay her an income and when she died he would inherit the flat. Madame Calment lived from the age of 90 to the age of 122. When she died the solicitor was already dead. I hope that noble Lords will not get themselves in that sort of position.
I am grateful to my noble friend Lady Dean for introducing this debate. As she said, we debated the issue of annuities for stakeholder pensions in this House on 24th June and 11th October, and my noble friend Lord Brooke is right in saying that I gave a firm reply to the debate at that time, though he is right also in saying that what I was replying to was a different proposition from the Opposition Front Bench to that which my noble friends have been putting forward tonight. I am still grateful for the opportunity of saying it again, though whether I give any more reassurance to the Opposition than I did at that time is extremely doubtful.
Let me explain the present situation. Currently, people in personal pension schemes—that is, defined contribution schemes as opposed to defined benefit, occupational or final salary schemes—must use their pension fund to purchase an annuity. They do not need to do that at the point of retirement; instead they can choose to draw an income from the pension fund by a process commonly known as the "income drawdown". That has been in place since 1995. But they must purchase an annuity by the age of 75 at the latest.
902 Income drawdown is a useful facility for providing people with a degree of flexibility over the timing of their annuity purchase, but it is not a panacea for all the perceived ills of annuities. I shall come on to the reasons why in a moment, but I should like to say a little more about annuities and why there is a requirement to purchase them.
The purpose of a pension is to provide a person with a secure, reliable, life-long income when he or she stops earning. As the noble Lord, Lord Taverne, rightly said, that is why we give tax relief on the contributions to a pension fund. Of course nobody knows how long retirement will be, so it is difficult to plan for the income to last and at the same time to maximise the level of that income. That is why we "annuitise" it; that is why we set up annuities which, in simple terms, insure the length of a person's life.
Annuity rates are decided by life expectancy, combined with yields from secure long-term investments such as gilts. I can say to my noble friend Lady Dean that they are not normally based on individual life expectancy; they are based on the life expectancy of all annuitants and do not relate to an individual's own life expectation. There are exceptions. There are different annuity rates for smokers. My noble friend Lady Farrington would obtain a better annuity than I would, though my dissolute life would probably overcome that if we were going to personalise it. Nevertheless, the essence of pooling arrangements underlies the basis on which annuities are given. Of course individuals who die young benefit the pool. Those who live longer draw from the pool as the noble Lord, Lord Taverne, said. It is not a matter of the money going into an insurance company. My noble friend Lady Dean talked of the whole fund reverting to the life company as a "windfall profit". That is simply not the case. The calculation and the market for annuities is competitive. It is based on the life expectancy for all people and there must be a balance between those who gain and those who lose.
§ Baroness Dean of Thornton-le-Fylde
My Lords, I thank my noble friend for giving way. Clearly he misunderstood my point. I did not say that the whole fund would revert to the life company as a windfall profit. I was referring to the amount above the maximum return on a contractual annuity whereby, if the earnings were above 3 per cent, it was that element that was a "windfall profit" to the company; that then went into the company's funds if the annuitant died.
§ Lord McIntosh of Haringey
My Lords, I shall come on to this point. That is why there are a variety of possible annuities available. It is a competitive market and if what is being offered is not competitive, then it is up to the person who has the fund from the personal pension to shop around to find the best. The average life expectancy affects the rates that life companies are able to offer for annuities and, as my noble friend Lord Brooke confirmed, people are liking longer. That is feeding through into lower annuities with the same pool of funds having to be stretched out to last longer.
903 Inflation is another factor that affects annuities. As a result of this Government's prudent handling of the economy, we now have inflation under firm control. During the time of the previous government, inflation averaged 6.6 per cent; under this Government it has been steadily reducing and now stands at 2.2 per cent. Interest rates mirror inflation. That means that they too have dropped and that has contributed to annuity rates coming down.
But there are two sides to the coin. It is not accidental that with low interest rates the capital value of equities has increased. Pension funds invest heavily in equities so people have larger funds with which to buy their annuity. With low inflation the real purchasing power of the annuity will last well into the future.
As I indicated to my noble friend Lady Dean, we should not forget that people have a choice, not only in the timing of their annuity purchase, but also in being able to shop around for the best annuity deal on offer. The noble Lord, Lord Astor, asked for more flexibility. Holders of personal pensions have the facility to exercise an open-market option when they buy an annuity. They may not only choose the best rate, but may also decide which type of annuity best suits their needs. Many people choose a flat-rate annuity where the level stays fixed for the rest of their life, but there are also index-linked annuities which guarantee to keep pace with inflation, and the newer breed of "with profits" annuities where pensioners can share in the returns from the investments of the annuity provider. The last category has been well developed by the insurance industry and answers the claim that innovation is not taking place.
Of course, the insurance industry and the Government are keen to find further ways of developing flexibility, from the Government's point of view, within the principles that govern pension funds. We will look at any country to see whether there are better ideas. The noble Lord, Lord Astor, referred to the Irish Republic. But that is a restrictive scheme. It has a substantial minimum pot before it comes into force and is severely restricted in the number of people who are allowed to make use of it.
Some people would say that annuities are poor value because of the lack of a competitive market, but we do not have any evidence in that respect. One of the virtues of annuities is that they are relatively simple compared to other financial products. This allows providers to reduce their overheads so that the costs and commissions paid on annuities are much lower than those for income drawdown, for example, which requires intensive fund management.
High costs is one of the reasons why income drawdown is unlikely to be suitable for most people. Costs, combined with high investment risks, mean that providers will generally recommend drawdown only for people with large pension funds. A number of noble Lords, including both my noble friends and the noble Lord, Lord Astor, said that they were arguing not only on behalf of the rich. I accept that that is their intention, but the fact is that some providers specify a 904 minimum level of around £100,000, while others say that it needs to be as high as a quarter of a million pounds. Few people have funds of that size. The contention that drawdown provides only for a minority is backed by a recent industry report indicating that there were only around 30,000 people in income drawdown arrangements. Therefore, that means that 30,000 people will be as upset at the age of 75, as noble Lords opposite seem to think will be the case.
The reason is very simple: the typical value annuity is bought with a pension fund of less than £30,000. A fund of that size could not sustain the risks associated with drawdown. The investment return on the fund must cover not only the income taken out, but also the high administration costs, inflation, and the fact that life expectancy does not remain constant but actually increases with age. To achieve the return needed, a substantial proportion of the fund must be placed in volatile investments. So there is a significant possibility that the value of the fund may fall rather than rise. This risk can be managed by a large fund using a comprehensive spread of investments, but a smaller fund would be much more vulnerable. That is not the way to secure a life-long income for retirement.
The proposal made by the noble Lord, Lord Higgins, in his amendment to the Welfare Reform and Pensions Bill, and which is reflected in the wording of the Question—although not in the speech—of my noble friend Lady Dean, is not about providing a better pension for the majority of people in this country. But that would not be a reason for opposing an easement for a minority if it could be shown to be beneficial and justified. So we must return to the purpose of pensions and the justification for spending the equivalent of £13 billion of public money a year in subsidising private pensions through tax relief.
The purpose of a pension is to provide a secure income throughout retirement. People will not then be likely to have to fall back on state benefits. If the pension were not secure—through no fault of the pensioner, necessarily, but perhaps, because of poor investment decisions—he or she might lose their pension income. The state would then end up paying twice over. Many of the people who have been lobbying Ministers to remove the 75-years age limit do not even need to draw their pension income; they already have security in their retirement.
Perhaps I may return to the issue of the need to charge tax, which would be necessary if we were to make substantial changes to the annuity requirement. There is a misconception that the annuity requirement is about the Inland Revenue taking back the tax reliefs given. It is not. It would be quite straightforward to recoup tax in other ways. As the noble Lord, Lord Taverne, pointed out, the essential point here is that pensions are not vehicles for passing wealth between generations. If they were to become so, as they might if the age 75 requirement were removed, we would have to reconsider the system of pension tax reliefs. We would also have to consider the consequences for other types of private pensions. In particular, we would have to consider the threat to 905 defined benefit pension schemes—occupational pension schemes—which might lose out if people were to leave them. It might make some of them non-viable and we would have a particular problem with unfunded public pensions, which could involve a considerable risk of expenditure for the Treasury.
I turn now to the point my noble friend Lady Dean made about the artificiality of the age 75 requirement and her proposal that it should be increased to the age of 80. The problem here is that the longer an income withdrawal arrangement continues, the greater the risk of depletion of the pension fund, leaving the pensioner reliant on state support. I am not saying that there will never have to be changes; indeed, life expectancy changes make that an inevitable consequence at some time. But change of the kind proposed by my noble friend would run the risk that we would depart from the essential purpose of pension arrangements; namely, to provide a secure income throughout retirement. As I believe the noble Lord, Lord Taverne, acknowledged, the current age 75 requirement strikes a reasonable balance between minimising the risk of the fund depleting too quickly and allowing a good measure of flexibility to the individual who can choose when to buy an annuity over a period of up to 25 years.
Perhaps I may conclude on a positive note. The Government are committed to improving pension provision in this country for all sections of the community. We have already made good progress with the proposals put forward in our Green Paper, which was published last December. Those proposals were taken forward in the Welfare Reform and Pensions Act and we are working in partnership with 906 the pensions industry further to develop and implement these ideas. We have received a great deal of support, for which we are grateful.
The pensions industry has also helped us to look at income drawdown. As has been said, the Inland Revenue has reviewed with industry representatives the current rules for personal pension income drawdown to see whether the rules are working well, or might be improved. That is important because, if we can streamline the process, it may assist the industry to provide a better product. However, as I said, that does not mean that changes in life expectancy may not cause changes in the age requirement in due course. Although the review is complete and the recommendations are currently being considered by Treasury Ministers, I have to say that the invitation which was issued by Stephen Timms (then the Minister for Social Security) on 11th March of this year—for anyone else outside to come forward with positive suggestions—has not achieved any positive results. No suggestions have been made for improvements other than those which have been drawn out in the course of the consultation process.
Therefore, I must return to what Ministers in the House of Commons have said. The Government recognise people's concerns. We are encouraging the financial sector to come forward with possible alternatives, but they must be practical and must address the central purpose of a pension. The Government believe that it is important for people to have a secure, reliable income for the whole of their retirement. It is not clear at present that anything other than an annuity can do this.
§ House adjourned at two minutes before nine o'clock.