So it appears Steve Webb spent Christmas thinking about pensions. (Well, didn’t we all? No?) And not satisfied with the pension freedoms promised for new pensioners this year, he’s been thinking about those who have already bought an annuity. After being told cashing in annuities was a no go, his new idea is to allow people to sell their annuity. In exchange for a lump sum, the buyer will continue to receive an income as long as the original annuitant lives.
I can see the appeal of this idea. But is it really in the consumer’s interest?
Let’s take – the highly simplified – case of fictional Freddy. At the age of 60 he bought an annuity with his £100,000 pension fund. Freddy had high blood pressure and high cholesterol, but he didn’t shop around, and instead bought an annuity from his original pension provider. So he got an income of £4,000 a year after tax.
Now, at age 65, he wants to exchange his annuity for a lump sum. The prospective buyer gets him in for a full medical, finds out he isn’t very well, puts a life expectancy on him of 12 years (which comes as bit of a shock to Freddy). So Freddy is giving up a total annuity income of £48,000. If we discount that in today’s money terms to take account of inflation it is perhaps worth £41,000. And let’s say the prospective buyer takes off a bit (partly because they are putting up the capital up front, and, partly, because they can), so they offer Freddy £37,000 for his annuity income. (I did say this was a simplified example.)
A full medical is going to be a necessity. Those who come up with shorter life expectancies won’t be offered very much for their annuity stream. And those with a longer life expectancy would probably be well advised to keep the annuity and get as much out of it as possible.
And who buys the annuity? I can see annuity providers might see this as a neat business prospect (especially in the New Freedom World when fewer people are going to be buying annuities), but presumably they have to buy second hand annuities in bulk to make the business proposition work. So only a few companies will be able to compete and that is never good news for the consumer price-wise.
And is tax still paid on the income stream according to the recipient’s tax status? If so, that may mean swapping to only 20% corporate tax. And in that case the Government may want to stem its potential losses and apply a tax charge upfront on sale of the second hand annuity. If so, that’s another big tax take for the Government today, rather than waiting for its jam tomorrow from annuity income.
(As an aside, if the tax is determined on the recipient’s status there may be a future market for higher rate taxpaying annuitants to sell their annuity to their lower taxpaying spouses or partners.)
Webb is fond of saying he favours setting people free, to spend their money as they see fit. But whilst this is difficult to oppose, I refuse to accept it as the blanket clincher to every argument. If the policy runs the risk of putting a significant number of people at a disadvantage then we need to stand up and say so.
This all boils down to the appeal of hard ready cash. Fictional Freddy will probably jump at the chance of £37,000 cash in hand. Most people prefer to have the cash in their bank account to do with as they will, rather than the steady drip of an annuity. And that creates eager sellers, and the probability of a dysfunctional market.
Annuities are not a bad product. But the way they have been bought has led, in some cases, to poor outcomes. But none of the pension freedom initiatives have addressed the basic problem that people have failed – and will continue to fail – to shop around.
I wish instead of considering traded annuities, Steve Webb had concentrated his energies over Christmas into thinking about how he – together with the FCA – can improve the way people buy retirement income products. So instead of policy kite flying, we could have had some productive practical policies to help people now and from April.