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Watchdog's blueprint for reform could declutter minefield surrounding buying annuities this year

Buying an annuity on retirement is likely to become less of a minefield this year once the Financial Conduct Authority decides on a blueprint for reform.

Six months ago the Association of British Insurers launched its own 'annuity window' which revealed a 31% difference between the best and worst rates, which even on a tiny £18,000 annuity would make a difference of £6500 over a 25-year retirement, and a 46% gap between best and worst enhanced annuities, equating to a difference of £14,100.

Pensions campaigner Dr Ros Altmann has accused the industry of pocketing £100 million a year from selling poor value annuities to retirees who fail to shop around, while the Financial Services Consumer Panel says buying an annuity online without advice can cost you more in hidden commissions deducted from your pot, than the fee you would pay an adviser.

But annuities are not the only option at retirement. Standard Life says it is now administering £10 billion of assets for pension customers who have opted for income drawdown, where the pension pot remains invested and can be tapped for income, while next month more generous withdrawal limits will be restored by the government.

Alastair Black, head of customer income at Standard Life, says: "Drawdown is rightly becoming more popular in relation to retirement income. It is more popular than annuities in countries like America, Canada and Australia. I wouldn't be surprised to see the UK go this way as more customers start to understand how drawdown works and see it as an attractive way of accessing their money and funding their retirement."

Richard Slater, partner at Deloitte, says: "It will not suit everyone and savers will need to take financial advice, but it allows retirees to live off the income generated from their pension fund and delay buying an annuity to get better value. However, people must remember there is a risk that annuity rates don't improve or worsen."

Douglas Baillie, Perthshire-based IFA and founder of comparemyannuity.com, says once the drawdown account is opened, you can access your tax-free cash when you actually need it.

"After all, what is the point in withdrawing a large sum from a tax-privileged personal pension and placing into a bank where it will earn very little, and what it does earn will be taxed as well. When you need some cash you can simply withdraw some of your lump sum (tax free), and top it up with a variable, taxable income so that the total net amount is the amount you need."

If you die before you start taking tax-free cash and income, the entire fund can pass to your family as a tax-free lump sum. If you die afterwards, the remaining fund can be used by a spouse to continue income drawdown or to buy an annuity.

But Mr Baillie warns: "There are no guarantees, and depending on how your fund is invested and how it performs, your future income, and the value of your remaining fund can go down or up in value."

Ian Finch, director at Martin Aitken Financial Services in Glasgow, says: "Five years ago people would say drawdown is only suitable for those with a £250,000 pot but our view is probably now £100,000."

From March drawdown will become more attractive as the government lifts the ceiling on how much income can be drawn down, from 100% to 120% of the best available annual annuity rate - as it was until 2009.

"The government reduced it because people were stripping out more income than their fund could support and investment returns were going down," Mr Finch says.

"The big thing with drawdown is can the client accept the risk of suffering a reduction in income at a future date, do they have other assets as back-up?"

Hybrid products guaranteeing an income level for three to five years are also available. There is also flexible drawdown, with no withdrawal restrictions, available to those who can have £20,000 a year of other secured income.

Mr Baillie says: "Most of the better personal pension plans that offer income drawdown are available via the internet online, so that you can view, plan and control your tax free cash and your future income needs."

Standard Life is lobbying for some "simple fixes" to the present regime to make drawdown more attractive.

It says pension drawdown limits should not be based solely on the current return available from gilts, as at present, but on a combination of gilt and corporate bond investments.

Mr Black says: "This could give a 60-year-old 15% to 20% more income."

It says a further 3% to 4% could be added simply by rounding up, instead of down, the gilt yields currently used, a further improvement would be using average yields over six months instead of a snapshot figure every month.

It wants a floor of 3% on the yield used, which would have protected pensioner income in a depressed 2012.

Finally, Standard calls for special drawdown rates for customers with reduced life expectancy, to put drawdown options on a level playing field with enhanced annuities.

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