The announcement by the chancellor in his March 2015 Budget that people will be able to sell their annuities for cash has sharply divided opinions.
Some see this as a natural extension of the April 2015 ‘freedom and choice’ agenda – if future pensioners can choose the mix of capital and income they want, why should existing pensioners be deprived of the same choice? But others fear that the complexity of valuing annuities and the risk of the ‘wrong people’ selling up could create just the sort of scandal that the financial services industry needs like a hole in the head. So who should we believe?
At heart, this is more of a philosophical question than a technical one. If a government can create a freedom which some people will use to their advantage but which might allow others to make poor choices, should it go ahead? For me, the key question is whether an appropriate level of consumer protection can be applied which will not be so onerous as to kill the market, but sufficient to make sure vulnerable – or misguided – people are not exploited.
So what would such a regime look like?
First, it is necessary to think about people who almost certainly should not sell their annuities. One such group is those on means-tested benefits such as pension credit or housing benefit. By definition, this group has so little regular income relative to their needs that the taxpayer is topping it up. It is very hard to see that this group should be going around sacrificing current income, even in return for a capital lump sum.
Indeed, people on low incomes could end up in the worst of all worlds if they are not careful. If someone sells an annuity and then renews his housing benefit claim, the local authority might well ask why their income has fallen. If he explains he has willingly chosen to surrender his income, the council may judge him to have done so deliberately in order to qualify for additional benefits and ‘deem’ him still to be in receipt of that income. This could make things very tight indeed.
Worse still, any capital sum received from selling an annuity would count as capital when someone is next assessed for benefit and could lead to him being disqualified from help altogether.
In the absence of a blanket ban on those on means-tested benefits selling their annuities, there needs to be a requirement for annuity buyers to ask if the seller is on benefits. If the answer is yes then at the very least the seller needs to demonstrate that the consequences of his actions have been fully explained to him, ideally by a financial adviser or, failing that, by a session on the phone with PensionWise.
Another concern that has been expressed is that sellers will not know the ‘true’ value of their annuity and might as a result get a poor outcome.
The best antidote to this in my view would be to ensure that the market is set up in a way that there are several potential buyers for each annuity. For this reason I welcome the government’s U-turn in allowing the original issuer of the annuity to offer a price to buy it back, albeit indirectly in most cases. If potential purchasers include the original seller, other life companies, pension funds and possibly other financial institutions, then the consumer will at least have a range of offers and will not be forced to accept the first price they are offered. If this can be achieved then the rather high profit margins which some have assumed would be a feature of this market can be driven out.
Another source of concern has been that people will be very disappointed by the prices they are offered because they got poor value in the first place, have already taken a series of payments since the annuity started and will now get ‘ripped off’ again. Having a large number of buyers will help with the last point, but recent trends in interest rates should also help. Indeed, in many ways, setting up a secondary market after a period of plunging annuity rates is the best possible time to do it. An annuity stream that was bought by a newly retired person in the late 1990s would cost roughly double for someone retiring now to buy at today’s annuity rates. According to some calculations, sellers could get a pleasant surprise with the capital sum they are offered simply because of the change in interest rates between when the product was purchased and the present day.
The secondary market could also offer one answer to the vexed question of what to do about people with guaranteed annuity rates under the ‘pension freedoms’ regime. At present, the problem is the people who have saved with products which offer them an attractive guaranteed rate of return but who want cash and who want it now. Some may be ‘insistent’ that they want cash even though an objective observer would conclude that they are going to get very poor value.
However, roll forward to April 2017 and a different opportunity presents itself. Individuals with GARs could take the generous guaranteed rate on the product and then sell it on immediately for cash. Provided that the frictional costs of this process are not excessive then this could offer a better outcome for people with guaranteed annuities than is currently on offer.
For those with larger annuities (not so far defined), the Treasury has said that there will be an ‘advice’ requirement, and the FCA is to consult shortly on the nature of that advice requirement. One concern is that if the FCA goes down the route of requiring new qualifications for advisers in this market, then this will both reduce the number of potential advisers and increase the costs. Neither of these seems to me to be a good outcome and the FCA should tread very carefully with regard to any new requirements for advisers.
As soon as the pension freedoms were originally announced, I started to hear from people who had been ‘forced’ to buy an annuity and who were resentful that they could not also opt for capital over income. I could not see a good reason why, in principle, they should not be afforded the same freedoms as those a few years younger. But at the same time it is clear that there are others – a majority according to the Treasury – for whom this would not be the best option. The challenge is to make sure that those who go down this route have the best possible access to the help they need to make the choice that is right for them.
Steve Webb is director of policy at Royal London and a former pensions minister
Key points
The announcement by the chancellor in his March 2015 Budget that people will be able to sell their annuities for cash has sharply divided opinions.
There needs to be a requirement for annuity buyers to ask if the seller is on benefits.
The secondary market could be one answer to the question of what do to about people with guaranteed annuity rates under the ‘pension freedoms’ regime.
