Let’s imagine the Tardis existed outside Saturday night television. That we really had the option of travelling back in time, perhaps just three years or so to a point where neither the pension freedoms nor the possibility of once-in-a-lifetime reforms to tax relief on pension contributions were considered as anything more than a remote possibility.
In those circumstances I would imagine the suggestion the Government might consider allowing retirees to sell annuities on the open market in exchange for a cash lump sum would be viewed as outlandish.
Ignoring the obvious questions about whether reviewing pension policy would really be the best use of a time machine, or just how big a lump sum someone with the ability to regenerate would receive for their annuity, I suspect we would see widespread debate regarding the annuity sale proposal in both the national and trade press. I would also expect the consultation to have received hundreds of responses from interested parties.
While it would be wrong to say that the annuity proposals have slipped completely under the radar, I wonder if there is a risk the magnitude of the pension freedoms changes and the tax relief proposals means that the creation of a secondary annuity market has not received the attention it deserves. The Treasury apparently received hundreds of responses to the pensions tax relief consultation, dwarfing the number of respondents (87) to its secondary annuity market call for evidence.
The main features of the annuity proposals are fairly straightforward to understand. Annuitants will have the option of selling their annuities, with the lump sum either being payable to a registered pension scheme, back to them personally or moved into a flexible annuity. If the funds are paid to a pension or remain in an annuity they will not immediately be taxed, though subsequent income will. If the lump sum is paid directly to the former annuitant, the payment will be taxable at the recipient’s marginal rate.
It sounds simple but as with flat rate tax relief on pension contributions – which has been promoted as the cleanest of the available options in that consultation – it is more complex than it sounds. Indeed, once we dig into the plans for the sale of annuities, issues become apparent.
The most frequently raised concern is the risk that those selling annuities will not obtain good value. The number of parties potentially involved in each transaction, all of whom will be looking to make a profit, will only have a detrimental effect on the value received by the person selling the annuity. Annuity purchasers will understandably build in a margin to ensure mortality risk is covered.
They will also be able to charge for the administration work involved in the purchase. When you add in charges for other parties that could potentially be involved (platforms, brokers, advisers and new pension providers, for example) there are a lot of fingers in the pie. And of course if the saver receives the lump sum personally, HMRC will also take a piece, as all tax liabilities will be brought forward to a single tax year. Many could be at risk of receiving a lump sum that represents extremely poor value when compared to the guaranteed income they are giving up. The question is: how many will be blind to the poor value on offer and still take the decision to sell?
Another important point, where the annuitant decides to move their funds into flexi-access drawdown, is that they are not defaulted back into a personal pension offered by their annuity provider, or perhaps one linked to a broker. We do not want a situation where someone has received a poor value annuity through the failures of the open market option and is then led straight back into a poor pension – whether the poor value is represented by high charges, poor investment options or administrative issues – because of a second failure to consider the open market.
Wider issues with the proposals are clear from the fact that, even having had time to consider responses to the initial consultation, the Treasury is yet to confirm how it intends to deal with several concerns. Death notification is probably the biggest, with the issue being that once the annuity has been sold for a cash lump sum the family of the annuitant is less likely to remember to notify the insurer of the former annuitant’s death. On top of this, the Government has yet to make it clear just how it intends to deal with dependant consent in relation to joint annuities, low value annuity buyback, the possibility of a tertiary market or communication regarding the range of annuities that can or cannot be sold.
The option to sell an annuity will undoubtedly be beneficial for some people. However, with the Government itself saying that “for most people, retaining an annuity will still be the best choice” the hope is that in 10 to 15 years’ time we are not wishing we really could go back in time and reverse the introduction of a policy that offers the possibility of serious client detriment if appropriate controls are not firmly in place.
Gareth James is head of technical resources at AJ Bell