Millions of workers are at risk of being mis-sold retirement products after being given "weak" and "misleading" advice by their pension fund, according to damning findings from the City watchdog.

In a report obtained exclusively by Times Online, the Financial Services Authority fired a broadside at insurers for failing to provide clear options to retirees when they come to choosing an annuity.

Insurers have been given six months to improve their act after finding that just over half of the industry charged 10 per cent more than the best annuity rates available.

Almost half of the industry gave insufficient information to customers, the FSA said, adding that there was a gap of around 20 per cent between the top and bottom annuity rates.

Sarah Wilson, the FSA's Insurance Sector Leader, said: "I am disappointed with the results of our review which show that almost 40 per cent of the wake-up material reviewed does not meet regulatory requirements.... a significant number of firms have improvements to make in this area if they are to meet the December 2008 TCF (treating customers fairly) deadline."

Most of those coming up to retirement will look to their pension fund to provide an income in retirement, unaware that they have the option to shop around.

Advisers and annuity providers have been urging the authorities to get tough on insurers who fail to give appropriate advice to policyholders.

Now, the regulator has accused the firms of failing to treat customers fairly and giving "weak" advice in a strongly worded report that contradicts the industry's own research, unveiled this week.

"There is still significant potential for customers to achieve higher incomes by exercising their option to shop around."

The report comes a day after insurance industry research boasted that the market delivers good rates for most customers.

The Association of British Insurers this week said around 85 per cent of single life level annuity customers receive a rate that is at least 95 per cent of the highest rate available.

The ABI also said firms were working to provide good advice to retirees about their option to buy an annuity from another provider.

However, the FSA said that 20 per cent of firms were in "clear breach of the rules" by providing unclear information which did not "enable a customer to make an informed decision about their retirement options."

The report said: "Very few firms mentioned the advantages of shopping around for customers with health problems, who could be better off buying an annuity from providers offering impaired life or enhanced annuity rates."

It added: "To comply with our rules... literature should include a clear message that exercising the open market option might result in a higher pension and is therefore worth investigating".

Insurers also gave "misleading" illustrations of their default annuities, even though they would result in significantly higher incomes for pensioners.

"This results in the policyholder getting a misleading view of the in-house pension and could lead them to underestimate the value of the guaranteed rate and choose an option where it would be lost," the report said.

Advisers and annuity firms are expected to seize on the report, and call for further action from the regulator.

One adviser said: "It's clear time is about to be called on the annuity cash cow. Insurance companies are putting their bottom line before treating their customers fairly."

The UK pension annuities market has tripled in size in the last 15 years. In 2007, premiums in the pension annuities market were over £11bn and over 400,000 contracts were sold, according to the ABI.

Almost two-thirds of annuitants arranged their annuity ‘internally’ through the provider of their private pension in 2007 with an average premium of £13,000.

The average premium for an annuity purchased ‘externally’ was £24,000.

The FSA said it will publish an investigation into delays by some firms in transferring funds next month.

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