Employers are not providing enough support to help staff make a decision about their annuity, according to a report by the National Association of Pension Funds (NAPF) and the Pensions Institute (PI) at Cass Business School.

The Treating DC scheme members fairly in retirement report found that almost half a million people that retire each year are left short-changed by up to £1 billion from their total future pension income due to a complex annuity system.

The report found that 80% of employees have retirement pots of less than £50,000, and most annuity advisers will not find it profitable enough to advise on pots of this size and so the open market option (OMO) where they can find the best products and rates are effectively shut.

Fewer than one in five people have the financial know-how needed to pick the right annuity at the best price. The rest lack sufficient understanding of factors like interest rates, inflation and longevity, and need some form of advice.

The report recommends that employers and trustees should be able to support staff with retirement decisions without fearing legal comeback; clearer and simpler rules need to be set for workplace advice, which could help create ‘safe harbours’ for employers to discuss pension matters with staff.

According to the NAPF and the PI, staying with the default option when buying an annuity and not shopping around for a better deal can wipe 30% off an employee’s annual pension income, and in some cases up to 50%.

The £1 billion loss could treble in size to £3 billion over the next decade as the annuity market matures and as up to 8 million people start being automatically enrolled into workplace pensions from October 2012.

Joanne Segars, chief executive of the NAPF, said: “There is no point in encouraging people to save if we do not help them get the most out of their savings. Too many end up stuck with the wrong annuity at a bad price. Those about to retire need to shop around for a good deal, but how can they do that if the shops are either shut or impossible to find?

“The way the market is priced and structured must become more transparent, and people need stronger support in picking the right annuity. The government and the industry must work harder to create a clearer, fairer system that delivers better value for money.”

Professor David Blake, director of the Pensions Institute at Cass Business School, said: “This report is a wake-up call to the pensions industry, the government and the regulators.

“If the annuity system is not radically overhauled, employees in defined contribution schemes in the private sector will continue to suffer massive detriment and the government’s new auto enrolment regime will fail the very people it aims to help secure financial independence in retirement.”

Tom McPhail, head of pensions research at Hargreaves Lansdown, added: “The pensions industry and the government have a responsibility to ensure that the information sent to investors in the run up to retirement makes it as easy as possible to shop around.

“This is something they have demonstrably failed to do in the past and even today it is proving a struggle to push insurance companies and pension schemes into giving their customers a fair deal.

“Other reforms are needed, including an easily accessible directory of shopping around brokers able to help investors, particularly those with small pots.

“The market capacity for this does exist, there are plenty of shopping around brokers able to assist investors even with relatively small retirement pots – contrary to the NAPF’s conclusions – however at present investors sometimes struggle to see past their existing insurer’s uncompetitive annuity terms and to find someone who can help them get a better deal.”

Read more articles on pension scheme annuity deals