12th March 2015 by John Lappin
The Government may be planning to give millions of annuitants the right and the ability to trade in their old annuities.
This means they won’t feel left out of the Freedom and Choice reforms, changes that are set to revolutionise retirement in the UK from next month.
Up till now and for the short term at least, an annuity decision looked like a permanent decision – the clue is in the name often used by the pension industry – the lifetime annuity.
That meant that what you exchanged your pension pot for in terms of an annuity income was pretty much what you got till you died. For the price of a lower income, you could also have bought annuity cover for your spouse after your death, factored in inflation, and even incorporated some investment risk perhaps with a with-profits annuity. Yet those decisions, having been made, couldn’t be changed.
But that sense of permanence may well be about to disappear. Annuitants can join the party. Tickets may be expensive however. The annuity you have, was calculated on a range of factors, some perhaps specific to you or even your postcode, with other factors depending on what was happening to the population at large mainly how long they are living.
It is a contract that both insurer and annuitant have entered into for the life of the latter (or so we thought). The price of unravelling the contract could be high for a number of reasons.
Insurers will have to take the interests and the capital of their business as a whole into account on the grounds that they must have enough capital to back all the annuity contracts they continue to pay.
They will argue that the calculations, administration, and perhaps the cost of selling out of the investments they hold to back the annuity will mean it may cost a whole lot more to convert back into cash than might be imagined.
There are also all sorts of financial planning considerations. An annuity – even a poor value one – is at least good for one thing – a guaranteed payment to a retiree for life.
Many financial planners would wince at someone who decided to forgo such an income for a short term consideration – say for example a world cruise – without a definite idea of how to replace that income.
In addition, the annuity depends on the gilt market, and many of these annuities were taken out when gilts offered better value. Here is the view of one chartered financial planner.
David Smith at Tilney Bestinvest says: “Annuity contracts are integrally linked to the gilt market and unwinding these will undoubtedly involve costs that will be passed on to the retirees in the surrender values on offer. Furthermore, in order to assess the lump sum value of an annuity some form of medical underwriting will be essential, and this will surely incur costs that will no doubt be reflected in the purchase price offered.
“Such costs will obviously have a greater effect on smaller annuity pots. Cashing in your guaranteed source of retirement income would be a serious financial decision, that could prove financially disastrous, and one which in most cases should only be taken in the light of professional advice, which is another cost a retiree would need to incur. The annuities attracting the highest surrender values will almost certainly be the ones you should not be selling, as these will reflect incomes locked-in when gilt yields were much higher.”
At Mindful Money, we can even envisage a bizarre situation where the fact that an annuitant is in ill health would technically mean the pension provider would want to pay them less, because they would have had to pay the annuity for less time. Could we see some strange reversal on an enhanced annuity, where a fit and active 70 year old would get a higher sum back because he or she was expected to live another 20 or 30 years, years which cost the insurer more?
Where we expect a lot of interest and a lot of arguments is where annuitants realise that they took out an annuity from their existing pension provider without thinking about it and without shopping around. In hindsight, they might say that otherwise they would have stayed invested, or bought inflation protection or looked after their wives or husbands with a joint life annuity.
But we also wonder if some annuitants when confronted with their poor original decision – and the small amount they are offered when they ask to unwind it, will be looking to complain about the original decision.
Of course, we don’t know the details. What is the income tax position if an annuitant converted their substantial in-payment pension into cash? What for that matter is the inheritance tax position given recent significant concessions around passing on pension wealth?
Could you change your annuity and make this more advantageous? It could see some annuitants converting their annuity into something that is a lot better for them. It is more likely to see a big dash to take the cash. The expected policy therefore covers the full range of outcomes from perfectly sensible because you have other income and made a poor decision to financially disastrous and probably every scenario in between.
One thing to consider – the policy may be promised next week but we think it will take a lot longer to bring into force. It may be a while before you can spring the annuity trap – that is, of course, if you feel trapped. Just make sure it’s the right decision for you.