The widely-anticipated move, announced by Chancellor George Osborne in his latest Budget, will create a secondary market in annuities in which third parties – which could include asset managers, pension funds, insurers and intermediaries – can buy the rights to annuity holders’ income streams by paying a lump sum.
Individuals selling their annuity income will be able to take the proceeds and save or spend them as they see fit, taxed only at their marginal rate. Currently people who have an annuity must pay at least 55% tax if they sell.
In the Budget documents the government estimates it will raise £535m in the 2016/17 tax year from the measures and a further £540 million in the following year, which is likely to come from the extra tax paid on the lump sums by existing annuity holders.
“Annuities have been irreversible lifetime decisions – until today,” said Rick Eling, senior client fund manager at Sanlam. “So it’s good news that poor decisions made in the past can now be unwound by the sale of the annuity, with tax only at marginal rates.”
However, Eling and most other financial advisers and annuity providers stress there remains a lot of uncertainty over how the new market would operate and what kind of return annuity holder might get for their policies.
“If someone wants to exit their annuity because they don’t think it is good value it is unrealistic to expect anyone to pay a good price for it, especially when the only reason they are buying it is to make a profit,” Carlton Hood, customer director at Old Mutual Wealth said.
“For a minority of people it may be the right decision but it is crucial that the customer fully understands the value of the guaranteed income they are sacrificing as well as any other benefits of the contract, such as a spouse’s annuity.”
Or as Chris Jackson, Deputy CEO – International Distribution at Natixis Global Asset Management put it: “a poor value annuity simply converts into a poor value lump sum.”
Income stream for sale
Under the proposed new trading system an annuity provider will continue to hold the underlying assets of the policy and, after any sale, will pay the annuity income to the third party for the lifetime of the original annuity holder. The government has ruled out allowing an annuity provider to buy back an annuity from an existing customer.
This decision alone is likely to generate a lot of processing costs. For example in medical underwriting as an individual’s health outlook may have changed since they bought their original. There will also be the difficulty of knowing when an original annuity holder may have died if the income is being paid to a third party.
“An annuity holder will likely already have paid for initial advice when buying the policy and paid the provider of their set up charges. In selling on the annuity there will be further administration costs for the annuity provider which will have to be paid while any buyer will want to factor in a profit,” said Phil Farrell, a partner at Quantum Advisory.
Farrell said because the income stream is tied to the lifetime of the original annuity holder an investor is effectively buying an income stream with an unknown term.
As with last year’s pension reforms, the government is removing barriers and challenging pensions industry to create a market that allows individuals the choice to spend their savings more flexibly. For many annuity sellers the new market will be a complicated process and one thing all participants can agree on is that there will be significantly more demand for financial advice.
