Changes due to come into effect from next April will allow people to sell existing annuity contracts on a secondary market. HM Revenue & Customs estimates 300,000 out of five million existing annuity holders will wish to take up the option and that more than 37,500 of those that do so in the first three years will be in receipt of means-tested benefits.
There is already a worry that those selling their annuity will not receive the best deal from buyers or may be worse off after selling the income they received. My biggest concern would be for those on means-tested benefits. These are the people who, being on a fixed, low level of income, are most likely to be tempted to give up their annuity in exchange for a cash lump sum. However, many of these are unlikely to fully appreciate the financial consequences for themselves should they do so.
They could find themselves paying tax for the first time on receipt of the lump sum (possibly with larger amounts at the higher rate) or even losing the whole of their benefit in consequence of the extra capital asset they have now secured.
For most means-tested benefits, including pension credit, the first £10,000 of any capital is normally ignored. Above that figure you are treated as having an “assumed income” of £1 a week for every £500 (or part of £500) of capital remaining. Some benefits, such as housing benefit and council tax support, also have a capital cut-off limit of £16,000, meaning if you have more than this you will then be ineligible to receive any of the benefit.
What is more, there could be problems in re-establishing benefit entitlements at a later date if, despite having spent most or all of the money received from the annuity sale, you are caught out by the deprivation of capital rules. These are imprecisely defined but could mean that if, in the (subjective) view of the Department for Work and Pensions, expenditure had been unnecessarily lavish or there was a suspicion that some of the money had been given away, the capital would be assumed to be still available to the claimant and benefits withheld or reduced in consequence.
All these complexities and uncertainties point to the desirability of people obtaining financial advice before giving up their annuities. The FCA is consulting on a minimum level at which a consumer must obtain advice, although this is likely to apply only to annuities with a high value and be largely out of reach of those currently claiming means-tested benefits.
As an extension of pension freedom, the opportunity to sell an existing annuity is, in principle, the right way to go overall. It will clearly benefit some annuitants. However, I fear that for those without better consumer protection it could be a disaster. We shall find out next year who really are the winners and losers from this further radical easement of the annuity rules.
Malcolm McLean is senior consultant at Barnett Waddingham