Second-hand annuities, one of the potentially unintended consequences of pensions freedom, are being considered for launch in 2017.
We have previously discussed the possible pitfalls facing both the buyers and sellers and will now look at the tax implications as well as the actual value of this market.
Investors in this embryonic market will, of course, be very keen to have a full understanding of the tax treatment of the income from their asset.
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The capital payment will be taxed in the hands of the seller, but what happens to the income stream payable for the lifetime of the former policyholder?
This has been subject to income tax – so what is its status when it is income in the hands of a broker or investors seeking to pool these assets and create a brand new market?
We think clear answers to these questions will be key to the success of this new market.
Sellers will also need to be advised about the irrevocable nature of the transaction and the risks to their long-term financial health and tax bill.
Annuitants may have been receiving their pension tax-free if it was less than their personal allowance, but the proceeds of the sale would be taxed at their marginal rate, which could reduce their payout substantially.
Alternatively, pensioners could pay the proceeds tax-free into a flexi-access drawdown account or flexi annuity.
However, according to government proposals, these arrangements would not receive pension tax relief, withdrawals would be taxed at the individual’s marginal rate via PAYE and they would not entitle the holder to tax-free cash.
The recent £10,000 annual allowance limit for defined contribution saving pots, introduced from 6 April 2015, is proposed to apply to annuity sellers from the date of the first receipt of cash.
The changes to tax treatment on death are also to apply to annuity sellers.
Similarly, for joint life annuities there would need to be an adviser for the second beneficiary to make sure their interests were protected and they were getting fair value for their lost benefits.
It is not clear whether the advice would have to be independent of the first adviser to ensure that the second pensioner’s interests were considered without undue influence.
Actuaries could value the policy and provide independent advice to pensioners, but the cost of such advice is likely to be too high for all but the largest policies.
Independent financial advisers would generally not have the skills to value the annuity in payment, but with some guidance about longevity and future yields, they could establish some ‘ball-park’ figures.
Take-up of Pension Wise so far has been limited for existing freedoms, but we are still only a few months into the new regime and so it is hard to tell if it will fill the gap for the second-hand market.
It has been suggested that policies with a value under £30,000, like transfer values out of a defined benefit scheme, would not have to be advised upon.
However, the decision to transfer is not directly analogous since the pension transferred would normally still be paid although from a different source, whereas following a second-hand sale a cash sum is realised instead of a pension.
In the case of a second-hand annuity, there is much more scope for an unrecoverable decision.
It will be very hard for pensioners to know if they are getting a fair price for their policies. An active, competitive, market with many players would be a healthy start.
However, are they then likely to be very disappointed in what they are offered?
A recent Which? survey found 26% of people would sell their annuities for cash. Of these, 45% would expect their entire remaining fund back and 65% said they would want at least 95% back.
Commentators have suggested that 20% to 40% of pensioners’ pots could be used up in the cost of selling, which the public is likely to find as unpalatable at current annuity levels.
Without adequate safeguards and the establishment of a healthy market, it is easy to see that this is another potential scandal in the wings – especially for the elderly, vulnerable, those on benefits who may lose eligibility for means-tested state support or those targeted by the unscrupulous, all of whom arguably have a greater need for advice.
Only time will tell how what the results of this new market will be, but we fear that without strong controls and close policing, there could be another pension scandal around the corner and one which our industry could and should do without.
Tim Bateman is a partner and Katie Dawson is an actuarial manager at Mazars