* UK to scrap requirement for pensioners to buy annuities
* Britons to face lower penalties for using savings early
* Finance ministry sees little immediate market impact
* Industry levy to fund free guidance for pensioners (Adds bond and equity market reaction, industry comment)
By David Milliken and William James
LONDON, July 21 Britain will give more workers a choice to cash in their pension savings, the government said on Monday, expanding reforms set out earlier this year that hit insurers' share prices.
Finance minister George Osborne caught Britain's pensions industry by surprise in March when he said he would scrap a rule forcing many people to buy an annuity, a financial product which converts a retiree's pension pot into a guaranteed income.
From April, people will also face much less of a tax penalty if they access their pension savings early at the age of 55.
Osborne said on Monday that these rights would apply to more pension schemes than originally planned, taking the total number of people affected to 18 million, over half the workforce.
The government said it was going ahead with its plans - seen as the biggest reform of pensions in a generation - after consulting industry, employers and consumer groups.
"It's right to support hard-working people that have taken the long-term decision to save for their future and I'm pleased that the responses we had to our proposals on making pensions more flexible have been overwhelmingly positive," Osborne said.
Osborne's Conservative Party saw a small boost in opinion polls after the reforms were announced earlier this year although it is now again lagging the opposition Labour party as May's national election approaches.
Companies which sell annuities will also be able to sell more complex products that do not pay a constant income and allow one-off lump-sum withdrawals. Some industry experts fear that people may be sold unsuitable investments.
"It will become increasingly difficult for ordinary investors to discern whether they are actually getting a good product or not," said Tom McPhail, head of pensions research at brokers Hargreaves Lansdown.
The government will offer free guidance for people looking to cash in their pensions, funded by a levy on the industry.
Insurers' shares were little changed. Shore Capital equity analyst Eamonn Flanagan said the moves were largely as expected.
But prices of long-dated British government bonds fell with 30-year yields up as much as 2 basis points on the day as investors feared the changes would reduce demand. Insurers have traditionally bought long-dated government bonds to cover annuity payouts.
The finance ministry said it expected the long-term effect would be small. "It is expected that there will still be a strong continuing demand for high-quality fixed-income assets, including government and corporate bonds," it said.
Some analysts have said the changes could give a short-run boost to tax receipts but impose long-term costs, if older people decide to draw down more taxable income early in their retirement, but potentially end up dependent on the state later.
The original plans set out in March only applied to defined-contribution workplace pensions, in which savers build up cash pots, most of which must be invested in annuities on retirement.
Monday's proposals extend the changes to funded defined-benefit schemes, which pay an income based on employees' final or average salary. Employees will not be able to take cash from the unfunded schemes which predominate in the public sector.
The government said most employees in defined-benefit schemes would be better off staying in. The industry estimated that only 10-20 percent of people in defined-benefit pension schemes would transfer out of them.
"We don't believe that there will be a significant flight from defined-benefit schemes, as some fear, because many people like the security of a reliable income," said John Cridland, director-general of the Confederation of British Industry.
However some pension schemes might need to hold more liquid assets to enable withdrawals, the finance ministry said.
The reform plans have raised questions over how insurers will be affected by a dip in demand for annuities if there is no longer a requirement for retirees to buy them.
When the shake-up was announced in March, it hit shares in firms like Legal and General, Aviva and Standard Life who sell annuities. Those shares remain below their pre-announcement levels.
The government on Monday outlined new annuity products that allow early withdrawals and payments that vary in order to meet the demand of retirement expenses such as care costs.
Annuities may also provide a guaranteed payout, even if the recipient dies, for much longer than the current 10-year limit.
($1 = 0.5851 British Pounds) (Additional reporting by Andy Bruce and Nishant Kumar; Editing by Andrew Heavens and Mark Potter)