FCA review prompts calls for trivial commutation increase

The FCA’s thematic review of annuities, released on Friday, found that people with small pots were among the most likely to get a bad deal on an annuity, along with those who qualify for an enhanced annuity but do not shop around for the best option.

Those with small pension funds also have less choice of providers on the open market, the report found.

“More of these customers will get the best deals available to them from their existing pension provider, so our concerns here are with how the market serves these customers,” the report stated.

The limits on trivial commutation currently allow for two small pots of £2,000 each to be withdrawn from personal pension plans as a lump sum, but industry figures say this is not sufficient.

“The problem is that small pots can only trivially commute £2,000; it should be raised,” said Malcolm McLean, senior consultant at Barnett Waddingham. “There’s a case for raising the limit to £5,000 for two pots, giving [consumers] a better chance for getting a good deal.”

Consumers with a small pot of more than £2,000 faced a difficult situation, as they cannot afford to leave it invested and enter an income drawdown plan, said McLean.

Saq Hussain, head of defined contribution consulting for northern England at PwC, 
agreed the limit should be increased.

He added: “The challenge is to find the amount it’s capped at.”

He questioned whether even a £5,000 limit would make a significant difference to consumers. “There’s no easy answer, any answer will have its own problems.”

Raising the commutation could decrease the number of people with small pots buying annuities. Hussain said this would create savings on the administration costs of small pots and could lead to an increase in the competitiveness of annuities.

Assessing retirement options

The review also noted that consumers may require more clarity and engagement when assessing their retirement options.

“Most consumers find it difficult to assess risk and uncertainty in financial products. This results in a general lack of engagement in the annuity purchase, with many consumers struggling to evaluate the options to find the best deal at retirement,” the report stated.

Pension schemes can use their position to help ensure their members are prepared for their retirement by educating them about their options.

Many providers offer independent annuity-brokering advice, but consumers may be better served by advice on whether they should be looking at annuities in the first place, said Hussain.

Schemes can help their members by appointing retirement advisers to explain their options long before their retirement.

“Schemes appointing their own retirement adviser can start a lot earlier. People get to retirement and probably get the scare of their lives,” said Hussain.

Concerns were raised about the ability of smaller schemes to educate their members, as they are expected to face a greater challenge when auto-enrolling.

“Larger schemes are focused on education their members but smaller schemes will be preoccupied with auto-enrolment,” said Alan Higham, head of retirement insight at Fidelity.

Creating an annuity quality mark could also create savings for annuity providers seeking customers, he added.

¹The original version of this article said only three of the annuity providers offered enhanced annuities, rather than annuities for small pots, on the open market. This has been updated.