April saw the launch of no fewer than three separate consultations about the next big change to the retirement landscape – the introduction of a secondary annuity market due to be implemented next year. So, will this be an exciting new freedom for older people or is it a disaster waiting to happen?
Of most interest is the FCA consultation, which is open until 21 June. The FCA envisages three different parties to be regulated in this new market: annuity providers who might “buy back” their own annuities, other firms that might directly buy annuities and those that act as market intermediaries, such as brokers. The regulator says its aim is to protect consumers while “promoting effective competition”.
One of the key challenges of this new market is that it is very difficult to value an annuity in payment and consumers are unlikely to be in a position to know what is a fair price. Those who wish to buy an annuity will have to provide an estimate of what it would cost today to buy an equivalent income stream. This will give the consumer some sense of the value of what they are foregoing if they sell their annuity.
Firms wishing to buy annuities will be obliged to recommend sellers take advice and “shop around”. However, advice will only be mandatory for pots above a certain size and individuals with valuable pension rights spread across several pots might not come within the scope. It is also not yet clear how widely available such advice will be, nor what it might cost.
The best guarantee of consumers getting a decent price for their annuity will be if there are a good number of competing buyers. Interestingly, the FCA document suggests there could be as many as 10 potential direct buyers of annuities: seven insurers buying back “directly” and three other firms.
HM Revenue & Customs has published a separate consultation on the tax framework for the new market. The document makes clear individuals will be allowed to sell their annuity “regardless of whether the annuity being assigned is treated under the current tax rules as a lifetime annuity or a scheme pension”. The scope of this market is not just those that have used a pension pot to buy an individual annuity but could also include people who have rights under money purchase or defined benefit pension schemes where these are in the form of an annuity they can assign.
A seller will have three options: receive a cash lump sum, pay the proceeds into a flexi-access drawdown fund or use the proceeds to buy a flexible annuity or a different annuity (for example, a single life instead of a joint life). HMRC says lump-sum proceeds will be treated as pension income liable to tax at the member’s marginal rate of income tax but that payments into a flexi-access drawdown fund will not be taxable (though subsequent withdrawals will be taxed in the usual way).
Finally, the Treasury has recently concluded its own separate consultation on the “secondary legislation” needed to make the secondary annuity market a reality. This document includes a draft of the legislation that would surround the three new “specified activities” of buying an annuity, “buying back” an annuity and acting as an annuity broker. It confirms the Government has moved from its original position where it thought it would be a mistake to allow annuity providers to “buy back” annuities they had issued.
The key challenge is to make sure well-informed or well-advised consumers can take advantage of these new freedoms while protecting those for whom selling their annuity would be a mistake. But the consumer protection regime proposed is simply not strong enough. Potential buyers will be able to approach annuity holders directly, offer them a price that will sound attractive as a capital lump sum and carry out the transaction without the seller having shopped around, sought advice (for pots below the mandatory advice threshold) or even contacted the free Pension Wise guidance service.
At the very least, thought should be given to making sure those with worthwhile pension pots have obtained at least two quotes or even make sure that all sales happen through a regulated bureau or broker. Otherwise, despite all the careful consultation currently under way, this attempt to extend the laudable principle of pension “freedom” could backfire.
Steve Webb is director of policy at Royal London