March 2015 saw the publication of the Government Consultation on the creation of a secondary market for annuity sales, giving over five million existing pensioners the same right to access their pensions as that extended to those reaching retirement on 6 April 2015. Here we look at some of the issues raised in the Consultation and offer our own views.
An annuity is a policy from an insurance company that converts a pension fund, or part of a pension fund, into a regular pension income. The Government plans to remove existing restrictions on buying and selling annuities from April 2016, allowing the annuity holder to sell the right to the income that they receive without unwinding the original annuity contract. The annuity holder would receive a cash sum, which they would be able to take on a lump sum or place into a drawdown product, while the provider would continue to make regular annuity payments to the purchaser.
The Government's consultation proposes the withdrawal of the current punitive "unauthorised payment" tax charge usually levied at 55% (but which can run as high as 70%), thereby allowing annuity holders to assign their policy to institutional third parties like insurers and pension funds without a tax penalty. Instead, individuals would be taxed at their marginal rate.
In return, annuity holders can expect to receive a capital value which they will then be able to apply in one of three ways under the new pension freedoms including opting for an immediate lump sum, designating the funds for flexi-access drawdown, and/or the purchase of a flexible annuity. The new death benefit rules (pre and post age 75) will apply to former annuity holders and their beneficiaries.
Purchasers (e.g. insurers) will receive the income streams deriving from the annuity for the remainder of the annuity holder's life. Income will be treated as trading income or miscellaneous income for tax purposes depending on the purchaser's business activities.
So what's it worth?
The immediate question that springs to mind is how an annuity holder will determine whether a third party's offer to purchase represents good value. Clearly, without performing complex calculations and having regard to the investment environment, establishing fair value will prove difficult.
One option would be to impose a requirement on annuity purchasers to offer a benchmark "selling price" giving potential sellers a comparison figure. However, the level of detail required would clearly impact on the accuracy of the resulting figure: less information results in a quicker and less costly result but at the risk of inaccuracy; more information results in higher costs which will ultimately be put back on the selling annuity holder.
The provision of benchmark figures would however enable a purchaser to check and establish that the selling annuity holder has shopped around and obtained a number of quotes before choosing the particular provider, offering a further degree of consumer protection.
Equally, as the Consultation notes, considering whether to sell an annuity is not solely confined to establishing whether the offer represents fair value. The selling annuitant will also need to consider their own personal circumstances, financial needs, other income, existing wealth and any future provision for dependants.
Looking at it another way there's also going to be a tension between the need to establish certain levels of consumer protection on the one hand, and cost on the other, so that the development of the new secondary annuity market is not overly restricted.
The Consultation hints at a multi-layered approach to consumer protection: A formal regulated advice regime requiring annuity holders to take financial advice from an IFA. Separately, access to free and impartial tailored advice (possibly from the newly established Pension Wise service). Finally, standardised risk warnings delivered by the original annuity provider alerting potential sellers to the risks involved in disposing of their annuity and relevant factors they should consider.
And no, Mr Insurer, you can't buy your own annuity back!
The original annuity provider will not be able to re-purchase the annuity it issued from the annuity holder. The Consultation cites two reasons.
The first is that although an annuity provider would be under no requirement to re-purchase the annuity, a provider might come under public pressure to re-purchase a whole raft of annuities thought to offer poor value. In seeking to meet such a public demand, a provider could be forced to sell illiquid investments at short notice potentially resulting in the provider's solvency being compromised.
The second reason is the risk that consumers adopt tunnel vision, believing that the only way they can access the new pension freedoms is by selling their annuity back to their original provider, which would reduce shopping around to get the best deal and allow providers to be less competitive in their quotes. So for now, original providers will not be able to have their cake and eat it!
Wedlake Bell comment
Rather like the pension freedoms that have gone before it, the possibility of creating a secondary annuity market strikes us as innovative and forward thinking. Whether the apparent barriers to such a market can be overcome is another matter. The Government has stated that annuity providers and potential buyers should be allowed to develop the market, and that Westminster has no intention to "dictate a rigid mechanism".
This is certainly a positive sentiment but one wonders if it is wishful thinking considering the regulated world in which we live and the plethora of "gatekeepers" with a vested interest in ensuring an efficient and fair secondary market for consumers (e.g. FCA, ABI etc...). The Consultation is open for 12 weeks with responses due by 18 June. Clearly, whether the proposals will be taken forward will depend in large part on the outcome of the General Election on 7 May. As always, we will keep you updated.
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