5 January 2015
- Steve Webb calls for annuities to be cashed-in to extend pension freedom
- Many would love the chance to take the money instead of a tiny income
- But how would this work – what penalties and charges would there be for surrender?
Pensions Minister, Steve Webb, has called for an extension of the radical overhaul of pensions to include existing pensioners who may have bought annuities but are not happy with their deal. In principle, I think this would be extremely popular and is a chance to ensure that those who have missed out on the forthcoming pensions flexibility have some chance to be included in future.
But didn’t the Government remove mandatory annuitisation years ago In theory, yes, but only for those with very large pension funds. In practice, most had to annuitise. Until the recent Budget, anyone who wanted to take money out of their pension fund, and who didn’t have a huge fund, was effectively forced to buy an annuity.
Many would like the chance to undo their annuity: Over the past few years, annuity rates have fallen significantly, so that the amount of lifetime pension income customers received has been much lower. Some people have been happy to buy an annuity and, if they had help to choose the right type of product and get a good rate, they may well be satisfied. However there are many, many people who would love the chance to revisit their purchase.
Annuities are usually irreversible: I have heard from so many who say, if the pension freedoms had been in place earlier, they would never have bought an annuity but they had no choice at the time. They never wanted an annuity, often they are receiving very little income, have no inflation protection and would much rather undo the deal. Normally, this is not possible. Once bought, most annuity deals are irreversible, with six million people locked into annuities that they were often forced to buy because the pension rules did not give them any practical alternative, or because the annuity sales process did not ensure they received sufficient help when dealing with this decision.
So what Steve Webb is proposing is a radical departure from the status quo.
Who is this aimed at? This idea is particularly aimed at existing pensioners, those who have already bought annuities but wish they hadn’t. Hundreds of thousands of people each year have been buying these products, with a value of over £10billion per year, so this is a huge market that affects millions. It is less likely to be relevant to future pensioners, since the new freedoms mean annuities and pension products are likely to change. However, it is a way of dealing with past problems that could be popular with many retirees.
How will it work? That is the key question of course. The Minister seems to be suggesting that there may be a market in trading people’s annuities. So someone could approach a range of different companies who would be willing to buy ‘second-hand’ annuities and make you an offer. You might go along to a firm and say I have an annuity contract with Insurer XYZ that will pay me £1000 a year for the rest of my life. I am age 70 now, how much will you give me to buy this income stream from me? People could approach a range of different companies and see who makes them the best offer. They would then choose the firm to deal with, receive a cash lump sum (which presumably would be taxed as income in the year they receive the money) and the company they sell to will receive their £1000 a year income until they die. Obviously, the company offering to buy back an annuity will want to know the customer’s state of health, age, or other relevant circumstances in order to assess the value of the income stream. The mechanics are also likely to be complicated, because the insurer who sold the annuity would need to be told to pay the income to a different place and all parties would need to keep track of the original purchasers and be notified when they die.
Will this just be one person at a time or could it be for groups? There is the possibility that groups of people might want to buy back their annuities, or a market could develop where annuities from people in different age or health groups are joined together into a package of annuity income products and sold on to other investors.
Are there any precedents? There are examples of trading contracts that may be considered similar. For example traded life insurance policies and endowment policies. These contracts are written on individual lives, but were then bought and sold by other firms, with the original purchaser receiving a cash sum in exchange for their rights under the original contract. Unfortunately, the markets in these products did not work out well for many of the parties involved. The surrender penalties were often significant.
What will it cost? This is the big question! Again, nobody knows as this has never been done before. However it is certain that there will be charges for cashing the annuity in and some form of surrender penalty. How much the customer will lose is not clear.
Could this be done in other ways? An easier way for this to be done would be for the original company that sold someone their annuity to buy it back from them. This would not involve third parties, but of course the customer is then reliant on only one company to offer them a fair price, without the competition of a market-place. I could imagine this might work in cases where customers feel they were mis-sold an annuity in the first place and the insurer thinks they have a case for a claim. Rather than protracted wrangling, they might offer to buy the annuity back – this could even depend on whether Regulators threaten action on the basis of the FCA Thematic Review.
So is it a good idea? I think this is definitely something worth exploring, but I cannot see it happening immediately. However, it is likely to be a popular idea with many of the five million people who have bought annuities in the past, especially those who feel left out of the new pension freedoms and would prefer to have the benefit of their pension fund rather than a non-inflation-linked and possibly rather small annuity income for life.