A new consultation paper, aiming to give pension savers more choice, information, control and value-for-money when they need to buy an annuity, was launched yesterday by the Inland Revenue and the Department for Work and Pensions.

Various factors including falling interest rates, gilt yields and annuity rates, increasing longevity, and the rapidly growing number of money purchase (DC) pension arrangements have fuelled considerable political pressure to reform the annuity system. The Government remains wedded to the belief that annuities are the right way to provide income in retirement, however. Firmly off the agenda is any relaxation of the current age 75 limit by which latest date an annuity must be bought with the proceeds of a DC pension fund. Likewise, there are no plans to allow people to extract capital from their pension funds during their lifetime (as can be done under American 401(k) plans, sometimes touted as a model).

The Government’s stance is for three reasons: the tax reliefs are provided to encourage saving for retirement and no other purpose; the financial efficiency of annuities, derived from pooling of risk; and annuities provide security against longevity and falling back on means-tested State benefits.

So although this paper is mainly about ways to help people get a better deal when they buy an annuity, the scope for innovation is limited. The two new proposals put forward are first, ways to facilitate switching between annuity providers; and second, a “limited period annuity”, which is a bit like staggered vesting except that all the tax-free cash would be taken immediately.

The paper acknowledges that like drawdown, because of mortality drag (ie loss of cross-subsidy from annuitants dying early) the latter idea would very largely suit holders of much more substantial than average funds. Thus although it may relieve some of the political pressure coming from the rich and their advisers, it is unlikely to be of much benefit to the mass of annuity purchasers.

On annuity switching, the paper seeks a middle way. It recognises that complete freedom of movement, enabling for example an annuitant whose health deteriorates to switch in mid-stream to a provider of impaired life annuities, would be a recipe for even lower annuity rates to new customers. The essential value of pooling of risk would be lost. This natural consequence of any significant growth in impaired life and ‘postcode-based’ annuities is often passed over by commentators who focus on the benefits for today’s annuitants alone.

Finally, much is made here of the FSA’s role in educating consumers in how to get the best deal, but as the FSA spends only 3% of its annual budget on education, the Government may be assuming too much.