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Paul Kennedy: What price second hand annuities?

Paul-Kennedy-MM-Peach-700.jpg

Ostensibly, pension annuities and discounted gift trusts have little in common other than both convey an income stream for life (to the annuitant in the case of the pension annuity and to the settlor with the DGT).

Admittedly, the mechanics, the parties and guarantees involved are wholly different but there is a commonality of core concept. Should the Government’s proposed second-hand annuity market come about a critical issue will surround what purchasers are prepared to pay as a “lump sum” in return for receiving the annuitant’s lifetime income stream.

While still at the consultation stage, the initial proposal is that the annuitant will not be able to sell their annuity back to the original provider or to a member of the general public. In effect, any sale will have to be to a corporation, fund or another life and pensions provider. Once an offer has been received and accepted, there are three options proposed. The seller can take the proceeds as a cash lump sum, move the proceeds into flexi-access drawdown or use them to purchase an alternative pension annuity.

Where taking the lump sum, the whole amount will be taxed to the individual’s marginal rate of income tax. If electing to move the money into flexi-access drawdown or purchasing an alternative pension annuity, it will be subject to income tax as and when the actual income is paid and received. For the purchaser, the personal tax regime will not apply, as they will be an institution, fund or provider. They will simply be taxed according to the regime applicable to them.

In the world of inheritance tax planning and DGTs, we have always had to calculate the theoretical market value of the DGT income stream. That is, what a purchaser would pay for the income stream payable to the settlor for the remainder of their life. There is no real active market so it has always largely been driven by actuarial principles and formula. The generally accepted methodology works on the basis that the purchaser of the settlor’s “annuity” would insure out the individual mortality risk and also expect a yield on their capital outlay. This effectively means they do not have to take a view on how long the settlor will live as their capital is protected by life insurance. Simplistically, the annual income stream needs to pay the cost of life insurance and additionally also give the desired net or “in-hand” yield on the capital purchase price.

Using these factors and it follows a purchaser would pay less where the cost of insurance is higher due to age or morbidity (because the amount they retain as net yield would be less) or so the argument goes, probably wouldn’t purchase at all if the settlor’s life is uninsurable (clarifying this par).

So purely for fun, I took a quick look at an example of the value we surmise for IHT purposes that a purchaser would pay for a DGT income stream and compared that with what insurance companies currently charge to buy an equivalent income steam from a pension annuity. I assumed a 70-year old in good health, living in a Norwich postcode and an annual level income stream of £3,000.

For IHT purposes, the DGT calculation would attribute a market value to the settlor’s lifetime income stream of approximately £34,000. Were we buying a pension annuity paying £3,000 per annum without guarantee then current best annuity rates indicate a purchase price of around £46,000 and with some providers it is a lot more. Of course, one would not expect an annuity company to buy an annuity at the same price it sold it and it remains to be seen what the second hand market will in fact offer as purchase prices.

Obviously, this comparison is a tad leftfield in the context of any new pension annuity market, not least because a pension annuity income stream is guaranteed and backed by an insurance company (possibly even with FSCS protection to boot) compared to the income stream from a trust and its investments. However, if only for fun, it will be interesting so see how what have been hypothetical values used for DGT purposes correlate into what the market is prepared to pay to buy an annuity. It may even knock into IHT planning because we may soon see a real life active market in the sale of annuities.

Paul Kennedy is head of tax and trust planning at Fidelity FundsNetwork

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Comments

There are 4 comments at the moment, we would love to hear your opinion too.

  1. I’m trapped by Standard Life regarding the protected rights aspect of my late husband’s pension. I did not want an annuity 5 years ago and do not want one now, but Standard Life will not release what started as a lump sum of £39,000 and despite the change in the law are forcing me into buying an annuity which of course I will then have to sell but all this seems entirely unecessary. What are my options?

  2. Please talk with a local Financial Adviser.

  3. Dear Susie

    Your option is either to take the annuity or be completely ripped off.

    1. I presume you are taking income. Then you have to work out how much you have already received and knock this off the original amount.
    2. Next: How old are you? Anyone buying this will work out how long they might receive the income before you die. This will depend on your age now, your health and your actuarial life span. The less time the less money.
    3. Lastly don’t forget our dear friends at Standard Life. They doubtless will also charge a fee in addition to 1. above.

    So unless there are startling new provisions from Mr Osborne it very much looks like your original £39,000 will be whittled down considerably – that is if there is a willing private buyer – or an annuity or investment firm or Standard Life are willing to buy it, which is by no means a given. Sure you can sell it if (for example) you are willing to accept a pittance, but otherwise I don’t much fancy your chances of a satisfactory outcome.

    I would be highly delighted to be proved wrong.

  4. Ps – Correction. No private buyer seems likely,. And if you do get the lolly there will be a tax charge, unless of course you transfer it to a drawdown or another annuity product. In which case it is still taxable (if you are a taxpayer) but this time on the drip rather than in a lump.

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