Will you sell your annuity?
UPDATE: Since writing this feature the Government has pushed back the date for selling annuities to April 2017. See Can I sell my annuity? for the most up-to-date information.
Currently, annuity sales are non-reversible. Beyond your cooling-off period (typically 30 days), you cannot cancel or change your policy in any way. However, to level the playing field with those who are retiring after April this year, the Chancellor has kicked off a consultation process to work out how existing policyholders could exchange their contract for a cash lump sum.
The Chancellor hopes that a secondhand market for annuities should be established from April 2016 but however unhappy you are with your annuity, would selling it be the right thing to do?
What should you consider?
Before making any decision, annuity holders will have to decide whether the lump sum they will get is enough to justify sacrificing an income that is guaranteed for life.
Perhaps unsurprisingly, research from IFA Portal Financial shows that people's expectations of the price they will be able to achieve for their annuity are unrealistic. It found that 66% would want 90% of its value back and a further 13% would want 80%.
As a result, many annuity holders are likely to be disappointed by the quotes they are offered. This is because annuity contracts are unlikely to be unwound by the insurance company when they are sold, rather they will be sold on to third parties such as institutional investors who will offer you a lump sum in return for your income.
In addition to the profits they will be seeking, there will also be costs such as in-depth medical checks for the person or duple selling their annuity.
This health check would be deemed vital by investors to ensure the income they are buying is not about to come to an abrupt halt. So, for example, if you have a standard annuity but your health has deteriorated or you have been diagnosed with a terminal illness, the price you would be offered would be based on your new, shorter life expectancy, not the one you had when you originally purchased the annuity.
Jamie Smith-Thompson, managing director of Portal Financial, says: "Anyone expecting to receive at least 90% of an annuity's true value if they sell it has unrealistic expectations. We would expect the likely figure to be between 60% and 70% before tax as a maximum but it could be significantly lower."
Another factor you will need to consider is tax. Although the punitive 55% death tax currently charged will be abolished, any cash paid back will still be subject to tax, reducing your lump sum even further.
As such, Andrew Tully, pensions technical director at MGM Advantage, is one of many experts who is concerned retirees could end up losing an awful lot of cash. "The issues are complex but I can't see how exchanging an income for cash upfront at significant discount would make sense. From our calculations, you could lose 30% or more of your potential income because of tax and upfront costs. It would seem crucial that people are compelled to take advice before making this decision."
However, while selling up may not make financial sense over the long term that does not mean people will not want to do it.
Jonathan Watts-Lay, a director at Wealth at Work, says: "On an economic level, it wouldn't be in anyone's interest to do this. But on an emotional level, you can see why they might be tempted.
"Take somebody who bought a standard annuity worth £30,000 two years ago. Let's say someone offered them £15,000 in return for that income – from an economic point of view it's not a great deal but you can see how they might think that £15,000 in their hand today would seem to be worth more to them." As the saying goes: a bird in the hand is worth two in the bush.
While costs might make cashing in a larger annuity and moving it into drawdown prohibitive, it could have more appeal to those whose annuity income is too small to achieve anything meaningful.
According to the Portal Financial research, 50% would consider selling their annuity if it "was too small", while 22% said they would be tempted if they could use the money for "a significant purchase".
As such, many people with smaller annuities may decide they would rather have a lump sum that could be used for something meaningful over an income that may only pay a few pounds a week.
How much cash could you get for your annuity?
Sheila, 61, purchased her annuity in December 2013, right before the new freedoms were announced in March 2014. Sheila had a life expectancy of 18 years due to high cholesterol and high blood pressure and got an enhanced annuity rate of 6% on a pension worth £60,000 (£3,600 a year).
Unfortunately, since she purchased her annuity her health has deteriorated and her life expectancy is now closer to 14 years. Now Sheila wants to take advantage of the new flexibilities but how much will she get for selling her annuity? Aside from the annuity, Sheila has other secure income valued at £10,000 a year.
How it might work in practice
|Notional annuity income remaining (based on 14 years' life expectancy following new underwriting)||£50,400|
|Costs (admin/health checks/risk of capital/ reinsurance)||-£10,000|
|Income tax on remaining pot of £40,400 (24%)||-£9,563|
Source: MGM Advantage, March 2015. The case study is an example of how it might work in practice but is illustrative only. This is all subject to a government consultation and subsequent legislation.
Pensions expert Ros Altmann pointed out some people may have significant other pension income (for example, their annuity was funded by an additional voluntary contribution plan). "Someone receiving £20 a week from a £20,000 AVC might prefer to have a cash lump sum even if the amount is discounted for transaction costs."
Other policyholders might have large debts or a mortgage they want or need to repay that are only accruing interest. Clearing those debts could be an effective use of a pension withdrawal and alleviate pressure on monthly budgets. Those in ill health may, too, be tempted. "If someone became very ill and is unlikely to live very long, or needs to pay for care, they might find a lump sum more useful, even if it's much less than their original pension," she adds. However, that would depend on finding an investor willing to buy the contract.
Altmann reckons most people will keep their annuity but says it's important that those who do have good reason to sell are able to do so. "Giving them the option is only fair. Many of those who bought annuities understandably feel aggrieved that their money has gone to an insurer for a relatively low income and with no inflation protection, whereas future savers can enjoy full freedom to choose what is best for themselves."
However, while the proposal might be welcome news to frustrated annuity holders, experts are warning that it is still very much at the consultation stage and, whatever the Chancellor may have said, there is a chance it won't get the green light.
Tom McPhail, head of pensions research at Hargreaves Lansdown, warns: "There are significant practical obstacles to overcome and this scheme may never get off the ground."
Problems, for example, surround how annuities would be fairly valued and whether or not annuity holders are required to take advice before selling up. McPhail says: "This would help to protect investors but would also add to the costs, possibly making it prohibitively expensive for smaller annuities. The median annuity purchase price for existing annuity contracts is around £20,000 and there are many hundreds of thousands of annuities in force that were purchased for just a few thousand pounds."
An effective market for selling annuities also needs to be established, not to mention a demand from investors. If there wasn't enough interest from annuity holders wanting to sell or investors wishing to buy, the market wouldn't be able to function. "There has to be volume in the market for it to work - you need the aggregation," adds Watts-Lay.
So as exciting as plans for re-selling annuities might be to frustrated policyholders, it is perhaps not wise to start planning how you'll spend the money just yet.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The period of time you’re allowed, after signing an agreement, to cancel it without incurring a financial penalty. Financial products including banking, credit, insurance, personal pensions and investments are subject to a 14-day cooling-off period (this is 30 days in the case of life insurance and personal pensions). The insurer or broker must refund any money paid by you within 30 days, although it has the right to deduct a reasonable admin charge, and a sum proportionate to the number of days’ cover you had. If you have any related credit agreements, these will also be cancelled.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.