The size of our pension incomes could soon be affected by where we live, but many of us already miss out on much larger pensions by not shopping around.
Legal & General (LSE: LGEN) caused a stir last week when it unveiled a pilot study with Hargreaves Lansdown (LSE: HL.) to use postcode data to determine annuity rates.
People in poorer areas don't tend to live as long, so the plan is to pay them a slightly higher pension to compensate for this. While the pilot is taking place (it's due to run for a couple of months) people in wealthier postcodes won't be affected and won't be offered lower pensions. But should the practice become formally adopted then wealthier pensioners are likely see their pension rates reduced to fund the higher payments being made elsewhere.
Legal & General has called this a natural evolution for annuities. As it points out, annuity rates already take age and sex into account. You can also get annuities that vary according to your medical history and take lifestyle factors such as the amount you drink and smoke into account.
Types of insurance, such as home and car insurance, have long used postcodes as a key factor in determining the amount we pay. So this is nothing new and follows a recent trend of innovation in insurance products, with pay-as-you-drive schemes for car insurance and health insurance offering free gym memberships.
Is it fair?
As you might expect, there have been some hysterical reactions in corners of the press, highlighting this as an attack on the middle classes. But I think it's more realistic to see this as redressing an imbalance that has benefitted wealthier pensioners in the past. It's also worth pointing out that it will only affect money-purchase pension schemes; pensions based upon final salaries would be unaffected.
However, I must admit to being a bit surprised by the example given in Legal & General's press release which showed an uplift of just over 1% in the pension paid out each year. This is the maximum difference it anticipates paying out, but it seems rather low given that there can be differences of up to ten years in life expectancy between some areas. The middle classes can breathe easy for the time being it would appear.
Boosting your annual pension
Rather than taking the drastic step of relocating to a slum to boost your pension, there are other ways to secure a better annuity rate. This is crucial because, unlike just about every other financial product these days, once you have chosen your annuity you can't switch it to another provider to get a better rate a few years later.
It's estimated that only one third of us shop around to see if we can get an annuity from someone other than the company that has managed our pension. This simple step, known as the open market option, could boost your payout by up to 15%.
About two in five of us are eligible for what is known as an impaired life annuity, because we smoke or have a health condition that reduces our life expectancy. Long-term smokers, for example, could get a pension income that is 20% higher. Again, many of us fail to investigate what is available and miss out on these higher rates.
Many people retiring now also have valuable pension guarantees, setting a minimum annuity rate that is likely to be significantly higher than the current market rate. This may limit the increase you can get from shopping around, but it's still worth looking nonetheless.
> Read more: Give Your Pension Income A Massive Boost!