Pensioners who delay sorting out their arrangements until the last moment risk losing their tax free lump sum and getting a lower retirement income, annuity experts warn.
People aged 55 to 75 have the option of continuing to contribute to their pension fund, to leave it untouched, or to draw an income through a process known as "unsecured pensions". However, on reaching age 75 they must buy an annuity or opt for an "alternatively secured pension".
A few pensioners choose to do the latter, which allows them to continue drawing income from their fund, but restricts them to the same amount of money they would have got from an annuity. The remaining fund will be taxed at 83% when the investor dies.
Most investors opt for an annuity. However, says Bob Bullivant of retirement specialist firm Annuity Direct, increasing numbers of 74-year-olds are leaving it too late to shop around for the best deal, referred to as "exercising the open market option".
This means they have to accept the annuity rate offered by their own pension company, rather than going for the highest market rate. In some cases, they are leaving it so late they miss out on the chance to take 25% of their pension fund as a tax free lump sum.
"If you are approaching your 75th birthday and are one of the increasing numbers of people who have decided to go to the wire before taking your annuity, it is crucial to give your adviser ample notice in order to make a smooth transition for transferring the funds," Bullivant says. "We have seen a number of clients who have not been warned by their pension companies as to the danger if they don't make arrangements well in advance."
He adds: "Some providers are much more efficient than others, but we would urge anyone who has deferred buying an annuity to be certain to start investigating all necessary arrangements at least six months before their 75th birthday.
"Otherwise they could face the calamitous loss of their tax-free lump sum – this is non-negotiable with the Revenue once you go past your 75th birthday."
Tom McPhail, of independent financial adviser Hargreaves Lansdown, says several factors might encourage people to defer buying annuities until they are in their seventies: the older they are when they buy, the better the income they will get; annuity rates are low at present; increasing longevity; and the better health of people in their sixties today compared with previous generations and their increasing willingness to continue working.
The inadequacy of some people's pension savings and the closure of final salary pension scheme may also be putting people off buying early, he says.
McPhail adds: "Once you reach your seventies, your health is likely to be less good, and you could be entitled to buy an "impaired life" annuity which will provide a much better income."
Standard Life, one of the biggest pension companies in the UK, says it sends out a pack of information six weeks before its pension policyholders hit their 75th birthday. This includes a quote for a Standard Life annuity, details of the policyholder's open market option and the alternative secured pension. However, McPhail says pensioners need more time than this: "Anything less than three months is starting to cut it fine."
Alasdair Buchanan of Scottish Life agrees: "We get reports from our system that identify when someone reaches their 74th birthday and we start trying to get in contact with them at that point."
Leslie Roscoe, who runs his own firm mending and selling domestic appliances in the North West, didn't sort out his pension until eight working days before his 75th birthday. "I didn't need the pension because I still run my own business: I'm in reasonably good health and I enjoy working so why give it up?"
He was aware of the need to convert his fund into an annuity by his 75th birthday, which fell on 9 April, and contacted Annuity Direct for advice just before Easter. He was told his pension company would not be working on Good Friday or Easter Monday, leaving him just three days to sort everything out.This was just enough time to apply for the tax free cash — worth £19,700 — but not to exercise his open market option.
Luckily Annuity Direct identified that his pensions came with the offer of guaranteed annuity rates, set in 1978, 1982 and 1988 when he took out the policies with NPI – rates more generous than those offered now.
Even so, Roscoe is disappointed with the resulting monthly income of £339, and says he would have preferred to continue keeping his money in a pension fund. "I wouldn't have bought an annuity now, if it hadn't been required by law," he says.
Compulsory annuitisation of pension funds at age 75 has become an election issue, with the Conservatives and Liberal Democrats promising to scrap this requirement if they win.
The age at which people can draw private pensions rose on 6 April from 50 to 55, and Bullivant said that even if the winning party doesn't scrap compulsory annuitisation altogether, it should consider raising the age limit to 80 to maintain the 25-year delay before investors crystalise their incomes.
Types of annuity
There are many different types of annuity to choose from:
Level annuity This pays a set amount each month. Your income will be higher at the beginning than that provided by other types of annuities, but because it does not change in amount it could be eroded by inflation.
Percentage increasing annuity Your annuity will rise by a fixed percentage, usually 3% a year, for a set number of years, usually a decade – although it can be longer. However, you pay for this by getting about 20%-30% less a month at the outset.
RPI-linked annuity Your monthly payout rises in line with inflation , but again you receive less income at the outset. Some insurance companies will reduce the amount you receive if RPI falls, so be careful to check the terms of the contract.
Enhanced/impaired annuity Take out one if you suffer a debilitating illness likely to shorten your life. The insurer will raise your payouts, often by 10%-15%.
Single life annuity The income will be paid to you alone. When you die, your annuity income will end.
Joint life annuity You can choose for your partner to receive a proportion, up to 100%, of your income after you die. This again will reduce the amount you receive.
Investment linked annuity Conventional level annuities offer the safety of a fixed income, but the trade-off is no control over the future investment of your pension fund. If you're prepared to take some risk in return for growth, you could consider an investment-linked annuity. The money you get each month is based on the stock markets – if the markets go up, so will your income – and vice versa.