Existing annuity holders – who may have been frustrated by the rate of income they received – will be able to exit their contracts for the first time and regain control of some of their savings. Here, we find out how the scheme will work and whether or not it will make sense for you.
The secondary annuity market is expected to launch in April 2017. The Treasury and the city watchdog, the Financial Conduct Authority (FCA), are working on rules to create a market that would function well for investors and provide suitable protection for sellers.
Steven Cameron, regulatory strategy director at retirement specialist Aegon, says: “One of the biggest challenges will be how to find the buyer who will pay most and getting assurance that the lump sum they are being offered is a fair swap for the guaranteed income they are sacrificing.
Approaching a range of potential buyers would be complex, costly and time-consuming. To make the market work, customers need to be able to provide their annuity, age and health details to a central point which can then seek ‘bids’ from interested buyers across the market.”
Tom McPhail, head of retirement policy at Hargreaves Lansdown, says that the key factors to a good marketplace will be competition through annuity brokers, combined with appropriate consumer safeguards.
The small print
While the final details are yet to be confirmed, it is clear that there will be lots of charges associated with selling an annuity. At the end of last year, it emerged that some annuity holders would have to take financial advice before selling. The government is concerned that, without the help of an expert, savers could make the wrong decision and run out of money, or fall victim to scams. Advice is estimated to cost as much as £1,000.
Adrian Walker, retirement planning manager at Old Mutual Wealth, says: “Advice will be vitally important, as this market will be one where the potential buyers will be much better informed than the sellers.”
Buyers are likely to be institutional investors (including annuity providers) who will require in-depth health checks to help assess how much they will pay for the annuity. These costs will be passed on to the annuity holder.
There will also be tax to pay on whatever you receive as a payout. It will be taxed as income – so at 20%, 40% or 45% depending on whether you are a basic-, higher-, or top-rate tax payer.
Andrew Tully, pensions technical director at Retirement Advantage, says: “This is where financial advice will become helpful as if you have a substantial payout, you could be pushed into a higher tax bracket. With professional help, you can be guided on how to place the money in a drawdown product and take the cash over two or even three tax years to avoid paying more to the taxman than you need to.”
How much will I get for my annuity?
The amount you might get for your annuity will depend on your age and health and many other complex factors including the income the annuity generates – and taking into account the various charges.
Take, for example, a 61-year-old woman who purchased her annuity in December 2013. She 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 December 2013, her health has deteriorated and her life expectancy is now likely to be nearer 14 years. Her other secure income is valued at £10,000 a year.
In this instance, Retirement Advantage calculates that a cash payout of £30,837 would be awarded for her annuity. This is calculated using a notional income of £50,400 over 14 years, minus £10,000 to pay for costs such as administration, health checks and advice, as well as a tax bill of £9,563 based on the remaining pot of £40,400.
Who should sell?
A survey by Old Mutual Wealth and YouGov suggested that fewer than 20% of people would consider selling their annuity, with the major factor for this reluctance being a concern they would not receive value for money.
“The secondary annuity market is likely to be relatively limited and attractive to those in receipt of a small regular payment – say £20 a year. For those people, a lump sum may be viewed as more valuable if they need the cash,” says Mr Walker.
Mr Tully agrees: “A lot of people who got poor rates in the first place and who might be tempted to sell up will simply find they get stung again if they get a poor payout on re-sale. It’s important not to make a hasty decision.”
But he does admit there could be opportunities for some people who are coming up to retirement and have a guaranteed annuity rate attached to a pension. “Those with a guaranteed annuity rate might do well to take the annuity and look to sell it straightaway.” This would only be suitable for people who had enough guaranteed income elsewhere.
Likewise, he adds that there may be good deals to be had for people who bought their annuity between eight and 10 years ago, as rates were particularly attractive then.
There is also the issue of a potential mismatch between the annuities investors want to buy and the annuities policyholders want to sell. Mr McPhail points out that it is the least healthy people who are likely to be the keenest to sell, but it also these people who may get the worst deals because their income may not last as long as a healthy policyholder’s and therefore appeal less to investors.
“Without suitable measures in place, it could be too easy for investors to end up selling-on their guaranteed incomes for rock-bottom prices. People who have shorter life expectancies might have preferred to keep hold of their cash and pass on what they don’t spend to loved ones. Yet these are the very people who are most likely to lose out if they cash in their annuity since they will get lower lump sums.”
Whatever your motivation, get a professional opinion to ensure you’re doing the right thing and not jeopardising your financial security later in life.
What should you do with the cash payout?
Unless you have an urgent need for the cash – for example, debts to repay – it’s vital sellers think carefully about what they do with their money to ensure it lasts as long as possible. While many might want to keep their money close, by placing it in a savings account, inflation means savers are risking serious capital erosion.
Alistair Cunningham, a chartered financial planner at Wingate Financial Planning, says: “Cash is the investment type that is most exposed to the risk of inflation. Over the longer term, it tends to underperform ‘real assets’ such as stocks and shares. Inflation is a very powerful destructive force.”
You will need to take some investment risk if you want to outperform inflation in the long term.
This means having some investments in equities. Placing it in a flexible drawdown product is an obvious choice so that it benefits from further stock market growth that can keep up with your withdrawals so you don’t run out of money. Otherwise, a tax-free stocks and shares Isa is a tax-efficient savings vehicle. You can save up to £15,240 in the 2016/2017 tax year.