Millions of people who were compelled to buy poor-value annuities may be able to sell back the investments under a radical extension to the pension reforms, details of which may be unveiled in next week’s Budget. They would receive a lump sum which they could invest in the hope of receiving a better return, or divert into paying off a debt.
Annuities have paid rock-bottom rates for some years. Yet, in many cases, people on the point of retirement had no other option but to use a pension pot to purchase an annuity, an insurance company investment which pays out a fixed income to the holder for life. The obligation to buy an annuity ends with the beginning of the pensions revolution on April 6 that will allow people to spend their pension as they wish.
Ministers are this week debating the reselling proposal but it already has the backing of Steve Webb, the pensions minister, and Ros Altmann, the government’s adviser on pensions. However, concerns surround how a secondary market in annuities would work and whether the six million pensioners who could be affected would all benefit from the new freedoms. Some experts fear a free-for-all which would hurt both consumers and insurance companies; they also warn of the potential for another mis-selling scandal.
In theory insurance companies could utilise rarely-used rules to carry out annuity “buybacks” from their customers. Yet in the absence of any competition, there would be a danger that annuity holders would receive poor value from their insurer. Instead the government is understood to favour the creation of an open market where a number of financial companies — probably insurers — could bid for any annuities being offered, thereby, in theory, producing a better deal for sellers.
The company buying back an annuity would effectively be taking a bet on how long that person would live and how long it would be receiving the income stream from the annuity. This means that insurers would have to carry out some medical underwriting to assess the annuitant’s life expectancy. The buyback scheme would not have time to become law in this parliament but it may feature as a consultation proposal in next week’s Budget and could be enacted by a future government.
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■ The pros
It could be a lifeline to the six million people in the UK who hold annuities, many of whom feel trapped in what they consider to be poor value products which they would not have bought if they had had any realistic alternative. It would also tap into a vein of deep dissatisfaction with existing annuity products, whose yields have plummeted in recent years as central banks have kept interest rates at rock-bottom levels. Among the people who could benefit are those who have other pensions and for whom the annuity is not a major source of their retirement income, those who need the money to repay debts or fund other health or care needs and those who purchased small annuities, for whom the small amount of regular income will make little difference to their standard of living.
Dr Altmann points out that, as things stand, these pensioners are missing out on the greater flexibility which comes into effect on April 6 and will permit people entering retirement to take their entire pension pot as a lump sum. The new annuity buyback proposal would help redress that imbalance and help many people who are currently stuck in an annuity that they never wanted to buy.
Dr Altmann adds: “If these proposals go ahead no one will be forced to sell an annuity — it will be up to them. However, it will give people an option that they never had before.”
■ The cons
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Tom McPhail, of Hargreaves Lansdown, the wealth manager, says there are risks and costs attached to the proposed plan that could outweigh any potential benefits. He warns: “If an investor bought a poor-value annuity, selling it on won’t make it a better deal.”
It will also be difficult for ordinary investors to work out if they would be better off, says John Fox, director of Liberty Sipp, the pension provider. He says: “The maths involved in calculating the value of these complex products is beyond most astrophysicists.”
The result, he says, is that those thinking of selling annuities will need to take advice, which will cost money, as will the medical underwriting required, and that will eat into any lump sum they may receive from a sale.
Mr Fox adds: “If lots of customers want to cash in their annuities that could put many insurers under severe strain, as they don’t keep all their assets in cash and would have to sell other assets.
“There’s also a danger that people who feel they got a raw deal when they bought an annuity could end up getting a worse one by cashing it in. If that happens the people who benefit most will be the solicitors who already scent the possibility of a mis-selling scandal.”