Annuity confusion?

A reader from Dorset is confused over whose responsibility it is for picking an annuity.

Our pensions expert, Tom McPhail, a leading commentator on pensions at Hargreaves Lansdown with broad experience of pensions and investment related issues, takes him through the problem.

Peter from Christchurch asks:

I am a deferred member of a pension scheme that was sold by a solvent German company to a solvent UK company in 2002. Post-sale the underfunded DB pension scheme was wound up and following many battles the scheme managed to get more monies into the pot but the scheme is still only approx 65 per cent funded.

At the time of the winding up the stock market was at an all time low and the trustees of the scheme were advised to put all monies into a pension annuity company in order to 'preserve' benefits and to avoid further fund value loss.

I put a question to the administrators of the scheme as follows: An article has appeared in the Sunday press, apparently it is prudent for a retiree to have considered the following points before buying an annuity to ensure that the purchased annuity best fits the retiree's requirements 1) Do you have health problems, or have you had any in the past? If so, an enhanced annuity may be your best bet, 2) Do you want to make sure that your annuity covers your partner? If so, a joint life annuity may be worth considering, 3) Do you want to ensure that your annuity is protected against inflation? If so, an index-linked annuity may be better than a level paying annuity, 4)What minimum period, known as the guarantee period, do you want your annuity to pay out for? Guarantees guard your family financially against your early death after retirement and 5) Do you want to buy an annuity now or delay for a while? Sometimes it maybe tax-efficient to delay getting an annuity. The question is whether we, or the pension annuity company, will be asking these questions of the deferred members? If not, should the trustees, and advisors, be flagging this with the pension annuity company now?

The answer came back as: The annuities referred to in the press article are those that are bought by members of a money purchase arrangement. The annuities the trustees have bought with the pension annuity company work in a different way - the trustees say what level and type of pension should be bought and the pension annuity company say how much it costs to buy this (in fact, as there was not enough money to buy the full level of benefits, the trustees have just bought the maximum pension that they could afford, with the structure determined by the scheme's rules and the split between different members determined by prescribed priority orders). All of the questions raised in the article relate to trying to ensure that the pension bought for a given amount of money purchase funds is the "best fit" for the member, so do not apply to the pension annuity company policy.?

I just need to ensure that the above advice is correct.

Tom replies

All of the comments from the newspaper are entirely appropriate for someone who is reaching retirement with a Money Purchase pension. This is a pension where the individual has control of their own pension fund, and has to bear all the investment risks.

The income they receive at retirement is based on using their retirement pot to buy an income from an annuity provider such as an insurance company. In these situations it is indeed essential to ensure that the retirement income you buy is the right ‘shape’ for your needs.

By contrast, in your situation it is the employer (in principle) who bears the investment risk. The scheme has clearly defined benefits, based on salary, length of service and so on.

As far as they are able, the trustees have sought to match the benefits laid down in the scheme rules, using the funds available to them. In this way, the deferred annuity purchased on your behalf is simply a reflection of the benefits you would have expected to receive from the original scheme, albeit perhaps at a lower level.

So basically, the trustees are right.

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