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AJ Bell: We need to wake up to secondary annuity threat

JamesGareth

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

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Comments

There are 10 comments at the moment, we would love to hear your opinion too.

  1. Excellent article,

  2. I sometimes wonder whether it’s lack of understanding, or vested self interest, but the utter denial in the industry virtually across the board and commentary around the pension “freedoms” legislation and now the annuities one is amazing.

    Do people such as yourself Gareth honestly never think, I wonder why George Osborne is doing this?

    Is it because he genuinely believes that it’s a good thing? That will benefit the country in the long term.

    Or do we think politics and what’s in his and the tory parties best interests might have something to do with it?

    I mean god it isn’t rocket science to work out that HMRC gets a massive short term tax boost and that suddenly there may be a few extra billion being spent in the economy, both of which make dear George look good.

    It also doesn’t take a rocket scientist to work out that most of the pensions being cashed in are by those who will be reliant on state benefits when they retire and that with a minimum income guarantee for pensioners, that pension they’ve just spent would have meant they cost the country less in the long term.

    Pension freedom is good for some people, but it’s a frankly stupid idea for the country in the long term. It’s primary beneficiaries are the wealthy, who don’t need to cash in their pensions and can use them for IHT planning and those on benefits who will cash in, spend and then rely on the rest of us to give them an income boost.

    And yet there is virtually no comment from anyone in this industry about it.

    Ironic that we are desperate to show the people of this country how ethical and wonderful we are after all the scandals and yet when the opportunity presents itself to stand up and do the right thing, all our “commentators” and spokespeople, seem to just rub our hands in glee and look for how much we can cream off the top, whilst pontificating about how worried they are people will get ripped off.

    Ironically they could be standing up and giving the public a reason to trust us, by explaining to them why what George is doing is actually really bad..

    Then we wonder why people tend not to trust most of us…..

    • It’s not our concern whether it’s good for the country or not. Our concern is whether it’s good for our clients or not. Which in the main it is.

      Do you really think the public would trust us more if we got up on our soapbox and told them they can’t be trusted to spend their own money and they must go back to letting insurers lock it away for their own good? And who are “the public” anyway? Why is the opinion of “the public” more important than the opinion of your clients?

    • Quite right – but I fear a lost cause now. The time to scream was when Osborne first announced the new flexibilities. But while I know that there were many who thought that it was a totally irresponsible move, their concerns were expressed privately. This contrasts with the very public cheers from the supporters of what was, after all, a very popular (and populist) move.

      The point is that, partially because of the complexity of the financial system that the industry, governments and others have been complicit in allowing to develop, Jo Public is not is a good position to make the decisions that Osborne is forcing them to make.

      I mean just ask those who have experience of administering pension funds what (not advised) members actually do when presented with choices over OMOs, cash commutation, pension increases etc. Take the cash and the pension with the biggest number next to it from the existing provider.

      The problem is that Osborne didn’t ask those administrators. Or anyone else. Why should he? He is not interested in what is best for the country. He is playing a political game and found a clever move: announce a popular policy, wrong-foot the opposition, and get a tax wind-fall.

      But the problem is that in a democracy it is very difficult to reverse populist measures introduced by irresponsible ‘leaders’. The flexibility cat is out of the bag and I can’t see any realistic way of getting it back in.

      So I think that this explains the relative lack of interest in the secondary annuity market proposal (apart from those who have pointed out the many technical difficulties): The war has already been lost, so why bother with this particular battle?

  3. Guaranteed benefits given up, legitimate contracts broken, transfer analysis costs, pension transfer specialist costs, purchaser profit margins etc etc. I sincerely hope this crazy idea never, ever makes it out of the box.

  4. excellent article, and I agree with Mark Coulter wholeheartedly.

  5. Duncan Gafney – you sound like me shouting at the telly during a Budget speech. Unfortunately in this case you seem to have misdirected your rant at an article that was measured and thoughtful.

  6. I imagine it will a re run of the pension freedoms with the main question from customers. Being “when will my money arrive”. At least last time they could normally know that the amount was correct.

  7. Although, at the end of the day, we have a responsibility to act in the best interests of our clients (regardless of whether you are pro or against the pension reforms) I don’t believe we shouldn’t have any concern, at all, about what is good for the country. After all, sometimes our clients may also suffer if the country is run badly. We should all have some sense of the wider responsibility, surely. At least Duncan Gafney is trying to look at the bigger picture.

  8. Nick, I can just picture you shouting at the telly during a Budget speech. Funny.

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