You would have to be significantly lacking in cynicism if you believe that the Government will not use next week’s budget statement to make announcements that they think will earn them peoples’ votes at the May General Election !!
The biggest, most dramatic and certainly unexpected change announced last year revolved around the removal of income caps on pension funds, allowing pensioners to ‘drawdown as much or as little as they want’ from their pension fund. While these changes have been welcomed, many people who had already purchased an annuity or who were members of final salary schemes, felt that these new ‘freedoms’ didn’t extend to them. The Government have certainly been looking at ways to address this.
In January 2015, Steve Webb went public with his plans to allow people to cash in their annuity for a one off lump sum, claiming that annuity customers around the country were ‘urging’ him to make this change. Making such an announcement four months before the General Election means that if he is sincere, he had better get a move on ! With this in mind many think that the forthcoming budget statement will start the process of making these changes legal.
It should be remembered that even if the announcement is made next week, it could still be many months, if not longer, before customers get the chance to take advantage of the changes to cash in an annuity. There would need to be industry wide consultation, draft bills written, changes and amendments and so on. It will certainly be the best part of a year or more before the bill is finally given Royal Assent – the moment it becomes law. Should there be a significant change in Government the plans could be scraped altogether.
Even if products do become available, it is questionable whether the actual products offered will be as attractive as the initial idea. While we could be completely wrong we think the following are likely to feature in a traded annuity market :
First we don’t believe that there will be any obligation on existing annuity providers to refund or return any part of the money they originally received from the customer when they first purchased their annuity. Having said that, many existing annuity providers may want to do this to reduce their risk of the customer living longer than anticipated and thereby reducing their profit. The customer may also get more money if, instead of dealing with their existing provider, they sell their regular income to a new provider who will give them an immediate lump sum.
Customers will almost certainly have to sell at a discount. As a very simple example, a pensioner with a life of expectancy of 10 years who received a gross (before tax) annuity income of £5,000 per annum, would receive £50,000 if they lived for exactly 10 years. Therefore expecting the customer to live for 10 years, the customer may be offered say £40,000 in exchange for the annuity income. The customer is giving up a potential £10,000 in the future for a guaranteed £40,000 now.
This could mean that if the customer dies after 2 years, the company who purchased the annuity income will be significantly out of pocket – as they would no longer be able to receive the annuity income. They have in effect will have paid 8 years income in advance, but only received 2 years income in return.
However if the customer survives for 15 years the company have got an even better deal, as there may not be any obligation on the provider to share this additional income with the original customer.
In all contracts that are based on a customer’s life expectancy there will be winners and losers, however who the winners are will not be known until the customer dies !
Finally the lump sum the customer receives will be liable to income tax. We cannot see how this will not be the case.
Therefore in the example above, a customer selling their annuity for £40,000 will have the sum further reduced by tax. Based on 2014 / 2015 tax rates we currently believe that a customer aged under 65 would have almost £6,000 to pay in tax*. This amount would be increased if the customer has other income.
We should stress that the assumptions above are pure speculation, but we don’t believe there are too many who would disagree with us at this stage. Product providers will undoubtedly need to work hard to deliver attractive products.
Finally as a customer focused business, our primary aim is that customers achieve outcomes that are suitable for them. It is therefore important that we continue to make you aware that while an immediate lump sum may be very useful and attractive, once it is gone that is it. An annuity on the other hand will continue to pay you a guaranteed income for the whole of your life, even if you die many years after your anticipated life expectancy – we hope you do.