Treasury plans to allow pensioners to trade in unwanted annuities for cash lump sums will need to be carefully considered.
In December the government announced that it will create a secondary market for those who have bought annuities and want to swap them for cash. The move is designed to allow those who have already bought an annuity the same level of freedom enjoyed by the newly retired.
Under the proposals, a firm could buy back the unwanted annuity from an individual, and effectively ‘sell’ the income stream to someone else. The annuity would continue on the same basis, with income payments diverted to the new owner until the death of the original annuitant.
What sounds a simple idea is, in reality, very complex, and there are still question marks over how such a system could be brought to the market.
“I am not convinced there are many people who will happily accept that their future income rests on the lifespan of someone else,” says Ian Price, divisional director at St. James’s Place.
“Assuming a willing buyer can be found, presumably age, gender and life expectancy would have to be matched with the original annuitant, but details of exactly how this will work in practice still isn’t clear,” continues Price.
The buyer would inevitably want an incentive for taking on someone else’s annuity and there would be costs for administration. It’s questionable therefore, whether people offloading their annuity would feel they were receiving value for money.
Sales to individuals could be facilitated through specialist firms, intermediaries, brokers and financial advisers, although another option is for sold annuities to be bundled together somehow and marketed to institutional investors.
Creating a Secondary annuity market: response to a call for evidence was published by the Treasury in December. It stated: “Some potential investors have indicated that they might seek to securitise annuities or place them in funds in order to make them available to other investors.”
Price says although it might make sense to trade in very small annuities for cash, people should think long and hard before giving up a secure income.
“People take out annuities because they want a guaranteed income for the rest of their life. In the majority of cases this ‘need’ does not suddenly go away,” he explains.
It is likely that the cash received from selling the annuity would be treated as income and taxed at the individual’s highest marginal rate. Although this is a more lenient tax rate, those looking to sell their annuity will still need to work out the tax implications before taking action.
“The second-hand annuity market is a further attempt by the government to make pensions more accessible,” says Price. “But freedom can come at a cost, and that cost is often unexpected tax bills.”
The government will consult with the Financial Conduct Authority on its approach to authorising permissions for firms to buy back annuities and ask what further steps are necessary to ensure investors are protected. The option to cash in is expected to be in place by April 2017.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.