Analysis: The government has confirmed it will soften the tax hit for those looking to take advantage of the secondary annuity market, but some experts are concerned the financial services industry holds all the cards in getting the best deal.
While a secondary market has been cautiously welcomed as an extension of the pension freedoms to 5m existing retirees, many have questioned its appropriateness for certain individuals and the pricing of those annuities for both buyers and sellers.
Last week the government stated it would put in place a requirement for individuals with “higher value” annuities to seek advice before cashing them in – although the exact threshold has not yet been determined. The market is tabled to launch in April 2017.
As a political soundbite it sounds quite good, but from a practical perspective I don’t think it’s a goer
Bob Scott, LCP
Under the current framework, those looking to sell their annuity would incur a tax charge of between 55 and 70 per cent, but the Treasury’s consultation response this week said the government would remove this charge so that people are charged at their marginal rate.
However, Bob Scott, senior partner at consultancy LCP, said the issue of taxation would then be shifted to the buyer of that annuity in terms of the income they receive. He also questioned how the issuing insurance company would be notified of the original annuitant’s death.
Scott added: “As a political soundbite it sounds quite good, but from a practical perspective I don’t think it’s a goer.”
Value judgment
Changes in assumptions of the annuitant’s health between purchasing the product and cashing it in could also lead to a poor deal for the individual, Scott said.
“When they sell annuities, insurance companies would err on the side of [individuals] living longer; when they buy them back they would err on the side of people living shorter,” he said.
But Tiziana Perrella, head of buyout at consultancy JLT Employee Benefits, said there is a big risk that in the quest to deliver fairness to current annuitants who may have received a bad deal, the move could heap one bad deal on top of the other if annuities are sold on at poor value.
Perrella described this as a zero-sum game, adding: “As there is a potential asymmetry in financial knowledge between buyers and sellers, there is clearly a risk that annuitants will settle for too low a value.
“Sellers could also suffer a tax hit or a loss of means tested benefits. The risk can be mitigated via a robust advice process, however the cost of this will limit the scope for transactions of this kind and will impact the growth of a market.”
What retirees want
Earlier this year adviser Portal Financial carried out a survey of 1,000 retired and non-retired respondents, which found 569 would consider selling their annuity.
However, around two-thirds (65 per cent) would expect to receive 90 per cent of the annuity’s value in exchange for surrendering.
Ben Roe, partner at consultancy Aon Hewitt, said that while the idea may initially be attractive to individuals, the price offered for their annuity may leave them disappointed.
Recycled annuities could offer income for DB, but buyer beware
DB schemes could face significant challenges when considering investing in bundled secondhand annuities, which could render them less attractive than existing bulk annuities, investment experts said earlier this year.
Gavin Markham, an associate at consultancy Barnett Waddingham, said: “While attractive pricing may clearly be a driver for schemes that are looking for long-term regular income streams, as a way of managing their risks they would only provide a rough form of matching for the scheme’s own pension commitments.”
But Adam Michaels, partner at consultancy LCP, said secondhand annuities could provide schemes with longevity protection as well as some protection against interest rates and inflation. But he added they would also have to offer additional return to make them more attractive than a buy-in via traditional bulk annuities.
“Insurers quite rightly will have to factor in the cost and risk they are taking on by allowing members to cash in their annuity and the potential for those with poorer life expectancies to want to cash in,” he said, “so there is a real risk that many individuals will be left disappointed once they see the amount that they are being offered.”
Advice hurdle
The Bank of England and financial services bill 2016 will beef up the government’s pension guidance service, Pension Wise, to cover demand from annuitants. It will also require that Financial Conduct Authority-regulated advisers check that annuitants have received appropriate advice before cashing in.
But Roe said greater clarity over the regulatory framework is needed. “Without this clarity we don’t think that advisers will be willing to enter into this market for fear of retrospective action,” he said.
LCP’s Scott said people are at risk of being “doubly disappointed” if that advice does not go their way. He said that while the advice requirement is essential it “won’t come cheap” and individuals will not be happy if the cost of that advice falls on them.
However he added that should the market get off the ground, it could be an attractive investment for defined benefit pension funds looking to match liabilities. But he added: “I think we’re quite a way from having something like that.”
