More than five million consumers will be able to sell on their annuities from April 2017, however there are risks for over-hasty consumers
When pensions ‘Freedom and Choice’ was announced most savers in Britain were over the moon. “Finally,” they said, “I’m free to use my money the way I choose”.
Less pleased were those savers who had already invested their money in annuity – some of which represented extremely poor value at the time of purchase. Many in that group understandably felt they were getting a bum deal.
The government swiftly opened a consultation on the potential resale of annuities and has now announced that from 6 April 2017 tax restrictions for people looking to sell their annuity will be removed. This shift will allow the five million people who have an annuity already, and anyone who purchases an annuity in the future, to sell their right to future income for an upfront cash sum.
However, even the government is preaching caution, reiterating several times on its website that for most people re-selling an annuity will not be the best choice.
For most people, sticking with an annuity is the right thing to do”
The Economic Secretary to the Treasury Harriett Baldwin said: “For most people, sticking with an annuity is the right thing to do. But there will be some who would welcome being able to draw on that money as they choose - the same freedom we gave people approaching retirement in April this year.”
Minister for pensions, Baroness Altmann said: “Keeping an annuity will still be the right decision for the majority of people. But some were forced to buy annuities in the past that may not have been suitable for them – and I am delighted that this reform will allow more people greater choice and the opportunity of a more flexible income stream.”
The pensions industry is even more circumspect with many experts expressing concern about the possibility for people to make poor choices, the pressure on the advice market and the impact of more regulation on the industry.
Five ways to help people make the right choices
1. Issue appropriate warnings
Like the government itself most commentators are keen to reiterate that selling on an annuity will often be the wrong thing to do.
Malcolm McLean, a senior consultant at Barnett Waddingham, said: “Whereas many annuitants will welcome the opportunity to exchange core value annuities for cash, the government clearly shares the view of many advisers that for the ‘vast majority of customers, selling annuity will not be the best decision’.
“This must be reinforced in all messages that are sent out direct to consumers over the next 12 months.”
2. Getting advice
Advice will be crucial. The government has already confirmed that it will extend Pension Wise to cover the secondary annuity market and that advice will be a requirement for individuals with annuities over a certain threshold (yet to be decided).
Richard Parkin, head of retirement at Fidelity International, commented: “With these benefits come significant risks for consumers who are giving up guarantees in return for cash. In essence, this market combines the complexity of defined benefit transfers with the risks of pension freedom.
“We would therefore expect to see similar levels of consumer protection and requirements for advice that we have for these transactions. We cannot afford to skimp on protecting customers in pursuit of making transactions easy.
We cannot afford to skimp on protecting customers in pursuit of making transactions easy”
“As with all retirement choices the key will be to help consumers get affordable expert help.”
Gareth Shaw, head of consumer affairs at Saga Investment Services, said: “Requiring advice is a good thing - and it’s important that the rules around advice take in the experiences of consumers since the pension freedoms were introduced.
“Extending Pension Wise is a helpful first step, but it won’t be enough for many people. Therefore, it’s vital that the Financial Advice Market Review and the next consultation on the annuity market works to create stronger links between Pension Wise and the advice industry.”
3. Consumer protection
The government has said it will work with the FCA, to put in place a consumer protection framework. It suggests that this could include consulting on a range of extra protections, such as risk warnings and ways for consumers to understand the fair value of their annuities.
However Rob Lawrence a pensions expert at law firm Pinsent Masons believes that consumer protection does not go far enough.
This would enable the individual to obtain a number of ‘bids’ for their annuity”
“Focusing on consumer protection measures is a positive step by the government but they should also give strong consideration to encouraging the establishment of some form of bidding platform.
“This would enable the individual to obtain a number of ‘bids’ for their annuity without having to separately approach a number of providers. This would serve to address some of the risk around the individual obtaining poor value for their annuity.”
4. What’s it worth?
Alongside the consumer protections the treasury has said it will work with the industry and the FCA to create a simple online tool to help consumers work out an estimated value of their annuity.
However Saga’s Shaw questions whether this is the best way to approach annuity holders, many of whom are elderly.
“The government has recommended the development of a tool or calculator, but what happens to people who aren’t digitally engaged but want to sell their annuity?”
What happens to people who aren’t digitally engaged”
There are also other factors, including health, which can impact what an annuity is worth, however it is not clear whether the government’s new tool will take these into account.
Douglas Anderson, Partner at Hymans Robertson, commented. “The biggest challenge here will be capturing health data to arrive at sensible life expectancy assumptions on an individual basis. This will be key to arriving at a fair price. Accurate life expectancy data is an essential building block for the second hand annuity market to work effectively.
“Doing this in an efficient and economical way, especially for low value annuities, will be the challenge for the industry. Perhaps lessons can be learned on simplified underwriting used within the protection industry.”
The biggest challenge here will be capturing health data to arrive at sensible life expectancy assumptions on an individual basis”
Annuity holders will also have to carefully consider their tax situation before deciding to take the plunge.
Steven Cameron, Regulatory Strategy Director at Aegon explained: “There are also the tax implications to consider. If an individual does assign their annuity for a lump sum, the sum will be taxed at their highest marginal rate. You may have a modest annuity of say £3000 per annum and depending on your other income, may be paying no tax on this. But if you assign it and receive say £50,000 you would pay 40% tax on part of this. If giving up a secure future income for life, we don’t want people to find they are ‘happy never after’.”
5. Who’s buying?
Many have questioned whether there would be a market for these second hand annuity products, but Anderson thinks that persistently low bond yields could help create demand. However, he warns that consumers will still need to be careful.
“Due to historically low bond yields, on the face of it, those trading in annuities could benefit, as investors are willing to pay more for the future cash flows. In the past 5 years, 10-year bond yields have fallen by 2.3%, which has contributed to the increase in the value of annuities.
It may not be as good a deal as it may first seem for the individual”
“This bull market in bonds means that annuitants who bought five years back could get back as much as they put in, despite having drawn an income for those five years, in theory. However, as much as 20% could be wiped off this value due to underwriting and other costs. This is because buyers will require a risk margin to reflect the uncertainty of how long the person will live, so underwriting and administration charges will be deducted – so it may not be as good a deal as it may first seem for the individual.”
Another factor than can affect value is who is buying the annuity. One big surprise is the announcement that annuity providers will be able to buy their own annuities back from policy holders.
Anderson believes this will make it easier to establish a more competitive market as the original providers may be able to offer better terms due to the expense and capital savings of cancelling the original policy.