A giant blow for freedom and for savers – that was the governing principle behind both Mr Osborne’s unilateral budget decision to make annuity buying optional and the reaction to it. Liberated from the dead hand of the unthinking state, people could be trusted to do the right thing with what was, after all, ” their money” and not be compelled to buy low-value annuities from a distrusted financial services industry. This was a policy with no downsides.
Pensions minster Steve Webb, in a remark he will surely live to regret, said he would not worry if lifetime savings were spent on a Lamborghini. As a Lib Dem, it was a cardinal belief that individuals can and should be trusted with “freedom”, he said. They could either buy an annuity or spend their savings freely and end up living on the state pension alone. They would not be destitute. It was their money and their lives.
But it is not “their money” and we all live in a society whose members’ decisions profoundly affect each other. Mr Webb, I assume, would not make this remark about individuals being free, as neighbours, to play offensively loud music, or free not to bin their household rubbish or free to refuse to school their children. Being free to binge your lifetime savings, which taxpayers have helped create, falls into the same category.
Every citizen in these island pays higher taxes than they otherwise would to compensate for the lack of tax coming from tax-sheltered pensions. The contributions to build up personal pension funds are allowable against tax and the funds, once acquired, pay no capital gains tax and no income tax on dividends. Up to 40% of the value of any pension fund is thus created through the construction of a watertight tax-free zone. We should care if the resulting money is spent on a Lamborghini: a chunk of the car belongs by right to taxpayers.
This tax-free zone has been created with a purpose: as a society, we believe that people should be encouraged to save in order to supplement what is one of the meanest state pensions in the western world . Few companies now offer generous retirement pensions and individuals are increasingly on their own if they want more than a subsistence pension of some £7,000 a year during the last 20 or so years of their lives. There is a cross-party consensus that individuals should be enrolled automatically in a pension-saving scheme. Only if they object should they be excused from socially necessary saving. Except now they can spend the proceeds as they like!
By far the best way of ensuring the certainty and continuity of income in retirement is via an annuity – notwithstanding the current low annuity rates because interest rates have touched 300-year lows (which will surely be short-lived). The principle is risk-pooling. Insurance companies know that on average, 65-year-olds will live until 83, if a man, and 86 if a woman – with variations depending on socioeconomic background, health and geography. But no single person can know whether he will live longer or shorter than the average. What to do?
Your best choice is to buy an annuity that will offer you more than any interest you could achieve if you invested on your own both because the funds revert to the insurance company on your death and because it can use funds from those who die earlier to help those who live longer. The insurance company is pooling risks for everyone’s advantage. The more retirees it insures, the better rates it can offer everyone because the more risk is being pooled.
However, in the name of more choice, Mr Osborne and Mr Webb have reduced our choices. (And, as things stand, Labour is, at the very least, not opposing the reforms.) At the moment, 400,000 people buy £11bn of annuities every year. We know from other countries that as soon as the requirement to buy an annuity is dropped, the numbers fall hugely. The less risk-pooling there is, the lower the annuity rates. So those who want to make what would have been a good choice are going to be penalised. A no-frills pension of £6,000 a year on a pot of £100k for a 65-year-old will fall to £5,000 or lower.
You can either accept that loss or find alternative better yielding safe investments. One obvious route will be to enter the buy-to-let market, thus driving up prices for first-time buyers still more. Our kids will thus pay the rent of a new class of grey landlords and home ownership will fall still further. Others will choose to draw down their savings more or less quickly until all they have left is the state pension – a new class of pensioner poor. Others with very large pension pots will live on the interest and dividends rather than buy an annuity, occasionally drawing on their capital, but passing on the funds to their children. Inequality of wealth will boom.
Meanwhile, insurance companies will lose a great part of the £11bn inflow they have been using to support long-term investment. To date, that has been invested in company and government bonds. But with more energy, imagination and drive, it could have been a rich source of long-term capital for British infrastructure projects – had the instruments been developed in which the insurance companies could have invested. Even as it was, the government has managed to coax the companies into coming up with £5bn a year on infrastructure over the next five years. But now an important source of the funding – annuity inflows – will evaporate.
It is true the annuity market was overstretched, offering indifferent and often wildly different rates. It was becoming ever more frayed at the edges and needed reform. The response should have been to redesign it and figure out ways it could have offered better rates with smarter investment vehicles, which is, in any case, likely to happen when interest rates rise. What we will have instead is more inequality, an escalating buy-to-let boom, more pensioner poverty, lower annuity-based pensions for those who chose them, less home-ownership and less infrastructure investment. That’s quite a haul.
This is a policy with enormous ramifications, affecting the decisions of millions who have saved in good faith for decades, but it was announced with no prior consultation. It has taken a generation for us to recognise that selling council houses in the name of choice and freedom was not such a brilliant policy as homelessness rises, mobility declines and rents escalate. It will take less time for the same recognition to dawn on annuities.
Choice and freedom are great virtues, but so are risk-pooling, fairness and the recognition that the whole is more than the sum of its parts. The task of good government is to balance competing values. On Wednesday, it surrendered to just one.