Dovetailing with the new pension flexibilities introduced in April 2015, and continuing in the spirit of “freedom of choice”, HM Treasury recently announced that from 6 April 2017 pensioners will be able to sell their pension annuity on the open market to the highest bidder in exchange for a cash lump sum.
In our November 2015 article “From the Editor’s chair…” we anticipated the proposed reform of the pension annuities market. This came hot on the heels of (or, more accurately, it just very belatedly “followed”) the Government’s budget announcement in March 2015 that it proposed to extend retirement flexibilities to annuity holders, and its publication of a consultation and “call for evidence” on the creation of a secondary annuity market later that year.
On 15 December 2015, the Government published its response to the consultation and outlined its proposals for the creation of a secondary annuity market. The Economic Secretary to the Treasury, Harriett Baldwin, has announced that more than 5 million people with an existing annuity, and anyone who purchases an annuity in the future, will have the freedom to sell their annuity rights for an upfront cash sum.
The proposal
From April 2017, with the agreement of their annuity provider, individuals will have the opportunity to assign their annuity to a third party buyer in return for a capital lump sum or a drawdown pension which can be accessed flexibly. The annuity provider would continue to retain the underlying assets and would pay the annuity income to the third party for the lifetime of the annuity holder.
Whilst it is currently possible to sell an annuity income, the seller faces tax charges of up to 70% to do so. The Government plans to remove the pension tax restrictions on assigning annuities and also to remove the ‘unauthorised payment’ tax charge of 55% (or more) so that annuitants will be able to sell their annuity for an upfront cash lump sum and be taxed only at their marginal rate (except where there is a partial assignment or surrender, which will remain subject to these charges).
In order to be eligible for the secondary annuity market, the annuity must belong to an individual and be held in their own name. The Government has decided that DC annuities held as general scheme assets (and not in the name of the individual) will be out of scope. DB scheme annuities which are within an occupational scheme will also stay outside the scope of the proposed changes. However, scheme trustees will be able to permit assignment, if both they and the member wish to do so.
The impact of the changes on annuitants
It is currently estimated that there are more than 5 million pensioners with annuities. The Economic Secretary acknowledged that for most people, keeping their annuity will be the right decision, but that the proposed changes offer an opportunity for people to choose what they would prefer. There are those who will stand to benefit from the freedom to draw their money when they choose. Pensions Minister, Baroness Altmann observed that some people were “forced” to buy annuities in the past which may not have been suitable. Further, the changes put annuitants on the same footing as other pensioners already benefiting from the landmark pension flexibilities introduced in April 2015.
The proposed changes will enable annuitants to convert their right to future income streams into a lump sum to, for example, pay off debts or to gift money to cash-poor offspring. The Government’s proposal also offers opportunities for succession planning: currently many annuities end when the annuitant dies, however under the Government’s proposals the cash lump sum can be left to beneficiaries under the pensioner’s will (subject to any applicable Inheritance Tax).
Protective safeguards
When considering the Government’s proposal, an element of caution is required: the changes inevitably introduce the risk of bad deals, scams and fraud. However, the Government is working to establish effective safeguards to protect consumers with the following already proposed:
- Sellers with annuities valued above a certain threshold will be required to obtain regulated financial advice, helping to ensure that they know what their options are (although whether the advice is followed remains to be seen)
- The ‘Pensions Wise’ service will be extended to offer free and impartial advice to all those who hold annuities
- Government will work alongside the Financial Conduct Authority (FCA) to consider how consumer protection will apply in practice and to establish a robust consumer protection framework
- A new specific regulated activity for purchasing rights under an annuity on the secondary market will be created under FSMA, the Financial Services and Markets Act 2000
- Government and the FCA will develop a simple online tool to help annuity holders calculate the estimated value of their annuities
The Government has indicated that the FCA will be consulting during 2016 on their proposed rules around the secondary annuity market.
Annuity buy-back
The original annuity provider will have the option to buy back the annuity product, subject to a robust framework. The annuitant cannot however oblige the original annuity provider to buy back the annuity, nor vice versa; mutual agreement is required.
As mentioned above, the Government plans to introduce legislation to make buying back an annuity a regulated activity, and so providers will need to obtain permission in order to buy back their annuities. It is envisaged the buyback will be through actuarial intermediaries and not directly with the annuitant, except possibly is the case of low value annuities. Furthermore, annuities will not be made available for retail investors to purchase, but only to FCA authorised entities. It is hoped that these provisions will ensure stronger consumer protection and deter tax avoidance.
Whether insurers will wish to enter this market, either buying back their own annuities or as a purchaser on the secondary annuity market, remains to be seen. It is suggested that, in addition to insurers, registered pension schemes may become purchasers in the secondary market.
WB comment
The inevitable challenges involved in the creation of this completely new market call for substantial new legislation in the pension, tax and regulatory fields. Provided the appropriate framework of checks and balances is put in place, the proposed reform should be viewed as a positive opportunity for people to gain greater autonomy and flexibility over their retirement income and signifies the completion of the Government’s policy of facilitating consumer choice.
For further information please contact Emily Matthews at ematthews@wedlakebell.com.