If you have less than £5,000 in your pension pot then I believe you should be able to take it as cash. The fact is that annuities cannot really be bought with less than around £3,000 and those under £5,000 are not common. Anybody trying to shop around for an annuity after exercising the Open Market Option will already know that choices are limited. 

In 2007, the Association of British Insurers (ABI) reports that there were around 102,000 annuities sold with a value of less than £5,000.  That’s a lot of people being forced into very small annuities. Just to demonstrate the futility of this, a pension pot of £2,000 could earn you around £10 per month. What on earth are you going to do with that? Far better to take the £2,000 cash and do something useful with it.

I have mixed feelings about compulsory annuities anyway. Why should we be forced to take an annuity just because we reach the age of 75? What if your life expectancy is 5 years? Or even 1 year? I know you can get much more from an enhanced annuity that takes your health into account but surely you’d be better off with just the cash. And what about those of us who are reasonable financially sophisticated and would prefer to be in charge of our own finances – can we not choose for ourselves?

On the other hand, just like putting fluoride in the water supply, you manage to ensure the general welfare of the greatest number of people. You also remove the possibility of certain foolish actions – if I get my pension pot and bet it on a horse that loses I could end up relying on a state pension. The fact that the majority of your pension has to be paid to you monthly over a long period of time also pretty much precludes you going out and blowing it all on a gin palace pleasure boat (substitute your own favourite toy). You could argue that this prevents moral hazard e.g. I spend all my cash on fast cars, boats etc then rely upon the state to pay for my long term care.

I freely admit that I don’t know the answer. I hate being told what to do by a nanny state but I don’t want vulnerable members of our society blowing their hard earned pensions. I am certain though that people with smaller pensions pots (under £5,000) should simply be allowed to cash it in. There is no moral hazard here and no real impact on monthly income.

I mentioned administrative delays in pensions transfers in a previous post:

Insurers create administrative delays to make it harder to shop around. In fact the FSA is investigating allegations that insurers are delaying transfer of funds when policyholders want to transfer to another provider for their annuity.

Now Virgin Money, ever the customer champion(?), has done some research on the matter.  According to Virgin a fall in annuity rates of 0.5% could cost £10,000 over a 20 year period if the delay was just 3 months.  It really is time to act.

Britain’s soon-to-be pensioners are being cheated out of getting the best deal on their annuities. There are a number of key issues:

1. The product providers hide the fact that you can shop around. Most people don’t shop around because they don’t understand that it’s possible – providers call it exercising the Open Market Option. Why not just Shop Around? The Financial Services Authority (FSA) research showed that the difference between the best and the worst annuities is up to 20%. And remember, that’s 20% for the rest of a lifetime.

2. Insurers create administrative delays to make it harder to shop around. In fact the FSA is investigating allegations that insurers are delaying transfer of funds when policyholders want to transfer to another provider for their annuity.

3. We as a nation do not really understand pensions. For the majority of people, financial education is non-existent and pensions are complicated.

4. Most people cannot afford a financial adviser. Although often financial advisers receive their income through commission from product providers this is not possible when the amount in the pension is low. The Thoreson Review of Generic Financial Advice was designed “to ensure greater access to high quality affordable financial advice for those most vulnerable to the consequences of poor financial decision-making.” The final Thoreson Review was published in March 2008 and merits its own post really so I’ll save that for another day.

5. Other providers don’t want your business if you have less than £5,000 in your pension.

If we don’t start forcing the insurers to act with a conscience (or just comply with the FSA’s Treating Customers Fairly rules) we will have an ever increasing pool of impoverished pensioners. Those with the least provision for retirement will, as always, suffer the most.