Recently, pensions minister Steve Webb proposed a new second hand pension market where pensioners could swap their income-paying annuities for a cash sum. It may sound like an attractive idea on paper but it’s a complex one to say the least. Firstly the most important point being, how can one decide what is a good amount for his/her annuity and then what are the taxes involved?
Let’s understand what is been proposed by Steve Webb and whether it actually will be beneficial or not.
The Proposal and Road Ahead
Pensioners facing difficulty because of poor value or unsuitable annuity deals might be able to sell them for a cash amount paid upfront in future. His plan is that this scheme would stand valid only for the estimated 5million pensioners who have already retired. This clearly states that others who are already locked into an annuity will not be able to benefit from the new pension reforms.
As per Mr. Webb’s plan, the annuity would continue to be present even after you sold it in the second-hand market. Payments would be directed to the new owner and the pension would continue to pay out until you – not the new owner – died. However, ideally the new buyer would probably want an annuity that will continue until his or her death, rather than the actual owner’s. Therefore, it won’t come as a surprise if he expects a discount for the “second-hand” annuity. The buyer might also expect you to take a medical to confirm your good health. And the firm that carries out the transaction would expect a cut.
The biggest problem with this scheme for a buyer of someone’s annuity is that payments will cease on that person’s death, not buyers. There won’t be many people out there who will want an income that could end at any time? This reason alone could severely hamper the prospects for the new market and make second-hand prices unappealing. It’s possible that individual annuities could be bundled together and sold to institutional investors to get round this problem. There are also practical problems.
• A system needs to be devised by which the original insurer is informed of the death of the first owner of the annuity so that it can stop the payments. It’s possible that these problems could be overcome if insurers were prepared to link payments to the new owner’s death rather than the original owner’s, assuming similar life expectancy.
• The sale would probably be treated in the same way as accessing a person’s whole pension in one go under the pension freedoms that take effect in April. In other words, the money will be treated as income and taxed at the “marginal” or highest rate.
• Individuals won't trade second-hand annuities between themselves as they generally don’t have the necessary actuarial and longevity assessment skills. Meanwhile, no competitive market exists to ‘bid’ for annuity income streams and there is no obvious incentive to set one up.
Mr. Webb’s aims are undoubtedly noble however it would be very difficult to create an orderly market to allow annuities to be bought and sold.