We put by cash all our lives - and then we just chuck it away

As much as a quarter of the pension savings amassed over a working lifetime are being lost by hundreds of thousands of people because they don't seek the most competitive deal when they come to convert the cash into retirement income.

Critics warn that the vast majority of savers, having saved carefully for as long as 40 years for their pension, fail to spend even a couple of hours looking for a provider that offers good value for money.

Instead, they simply sign the papers sent by the life assurer with which they have saved, and buy their annuity - or annual income for life - from the same provider.

"There aren't many employees who would say no to a pay rise of 10 per cent for ever," says Tom McPhail of independent financial adviser (IFA) Hargreaves Lansdown.

"But by not shopping round for their retirement provision with different insurers, that is in effect what they are doing."

The problem only affects those who save into money purchase pension schemes, which have become more common as companies choose to offer them in place of expensive final salary schemes.

Savers build up a pot over their working life and, at retirement, must usually convert this into an income by buying an annuity.

That so many people fail to hunt for a competitive deal on these policies is a cause of mounting concern, particularly as, since 2002, pensions companies have been obliged to tell consumers about the "open market option" - their right to look elsewhere and check what their money might get with another annuity provider.

According to their own calculations, different insurers offer various rates for diverse types of annuity. Some are inflation-proofed, for example, and others are "enhanced", paying out more for smokers because of the higher probability of early death.

Insurers also calculate the "cost" of people's life expectancies in differing ways. So while one company may estimate it can afford to pay a 65-year-old with a £100,000 pension pot the monthly sum of £550 until his death, another might put the figure at £600.

The present system is "fundamentally dysfunctional", adds Mr McPhail, with the majority of purchasers buying either the wrong type of annuity or purchasing from the wrong source. "There are different types of annuity, such as 'level', 'index-linked', 'guaranteed', 'with spouse's benefit' etc - and many different providers.

He continues: "Consumers are prepared to shop around for a service such as fuel, house or car insurance, which will only cost them a few pounds if they get it wrong.

"However, they don't do it for their pension, which could give them typically 10 per cent - but as often much as 25 per cent more - to spend each year for the rest of their lives."

Even though it has been five years since insurers first had to publicise the open market option, the number of people comparing annuity rates has barely improved in that time.

The Financial Services Authority, the City watchdog, has invited interested parties to make suggestions on how the system could be improved.

Peter Quinton, founder of The Annuity Bureau and now sales director of retirement income provider Living Time, wants to see more people getting help on annuities from advisers, and thinks choice rather than inertia should be the default option.

"I feel that pension providers should actually be prevented from offering their own annuity product to people nearing retirement, and should force people to seek advice on getting the best option for them."

To do your own research on annuities, start at www.fsa.gov.uk/tables, where you will find comparative listings of the different rates provided by the various providers.

The Pensions Advisory Service - an independent non-profit organisation that provides free information and guidance - recommends consulting an IFA. Within the ranks of these advisers, there are many annuity specialists, including Hargreaves Lansdown, William Burrows Annuities, Annuity Direct and The Annuity Bureau.

The advice can be free - with the adviser paid for by commission from the annuity provider, or you can pay upfront.

An adviser can help you choose the type of annuity you need as well as the provider. For instance, do you need a joint life annuity to provide for a spouse if you die first? Do you want an element that guarantees to raise it by, say, 3 per cent a year? Will you use "drawdown", taking some money from your fund before you are obliged by law to buy an annuity?

Mr McPhail believes that many more people should be considering "invested annuities" - those that provide the possibility of growth, rather than those that convert your investment into a pre-determined income.

£3,600 cap on pension contributions

The Government has bowed to pressure from insurers and agreed a lower "cap" on the annual sum that workers can put into the new National Pension Savings Scheme. The Secretary of State for Pensions, John Hutton, has now proposed an annual contribution limit of £3,600 for the NPSS "personal accounts" scheme, which is due to be launched in 2012 to encourage people to save more for their old age.

This is much lower than the £5,000 cap previously suggested by the Government and consumer groups. The reduction is a victory for the Association of British Insurers, which had been lobbying for a £3,000 cap because it was worried that a higher threshold risked diverting savers' money away from existing private pension plans.

The NPSS is the Government's response to recommendations contained in Lord Turner's exhaustive report on the British public's pension provisions. He said people would have to retire much later and save more to afford a comfortable retirement.

Low- to medium-income workers will be automatically enrolled in an NPSS account - unless they deliberately opt out - contributing 4 per cent of their income. This will be topped up by 3 per cent contributions from their employer and 1 per cent in tax relief. The £3,600 cap on contributions will rise in line with average earnings.

Further consultation will now take place on the type of investments available - whether high-risk stock market bets or standard index trackers; who will run the NPSS; and how much it will cost to set up the scheme (and who will pay for it). The Government said that even with the cap, medium earners would be able to get up to two-thirds of their income in retirement.

Interesting? Click here to explore further