Sell your pension for cash: the two-minute briefing
It s been the dream of many an unhappy annuity buyer: sell the policy back to the insurer for a cash lump sum. And now the Government wants to make it a reality.
The pensions minister, Steve Webb, told The Telegraph last weekend that he d like to create a market for second-hand annuities, so that people who would prefer a lump sum to a regular income could simply sell their policy to the highest bidder.
It sounds a simple and attractive idea, but there are complexities. How could you be sure you were getting a good price for your annuity? And how much tax would you have to pay? We look at how such a market would work in practice.
Q How much would I get for my annuity if I sold it on this new market?
A: Under Mr Webb s plan, the annuity would continue to exist after you sold it in the second-hand market. Payment would be reassigned to the new owner and the pension would continue to pay out until you not the new owner died.
We can t be sure how much your annuity would fetch in these circumstances. But one possibility is that the annuity would be worth whatever it would cost someone of your age and life expectancy to buy the same annual income for life that you currently receive from the policy.
For example, let s say that you buy your annuity today at the age of 65 while you re in good health. Roughly speaking, the annuity company will assume that you ll live for another 20 years, until you are 85.
Now let s assume that you want to sell the annuity in five years time, when you are 70, and that you are still in good health then.
If the company that buys your annuity sells it on to another 70-year-old buyer in good health, it would presumably base its price to that buyer on what it would charge him or her for a new annuity at that time.
However, the new buyer would probably prefer an annuity that lasted until his or her death, rather than yours. Therefore, he is likely to expect a discount for the second-hand annuity. He 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.
If the second-hand annuity s value is based on that of a new one, it would clearly depend on the factors that influence annuity rates at that time. These include the interest paid on government bonds (gilts). If you bought when annuity rates were higher, it means gilts were cheaper then, so your annuity should fetch more now.
Q If there was no buyer for my annuity, couldn t the insurer just buy it back?
A: This is another possibility. Any annuity carries risk for an insurer because it doesn t know when you will die and therefore how much money it will pay out in total. If a particular insurer thinks it has taken on too much risk, it could reduce it by buying back annuities. For the policyholder, the question is what price is offered. Experts said insurers would want a discount, perhaps 20pc, on the true value of the annuity.
But what is that true value? It depends on your life expectancy at the time you want to sell. If your health has deteriorated since you bought the annuity, its value will be lower, reflecting the fact that it is likely to pay out for less time than originally expected.
Because of this, you would probably have to have a medical check-up before you got a trade-in value for your annuity.
Q What could go wrong with Mr Webb s plans for a new annuity market?
A: As mentioned above, the problem for a buyer of your annuity is that payments will cease on your death, not theirs. How many people will want an income that could end at any time? This could severely dent 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. There will need to be a mechanism 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.
Q Will these changes really happen and when will the new market be up and running?
A: Mr Webb said he would seek cross-party support to ensure that his plans could be implemented early in the next parliament, whichever party won the election.
Q If I sold my annuity, how much tax would I have to pay?
A: The sale would probably be treated in the same way as accessing your whole pension in one go under the pension freedoms that take effect in April. On other words, the money will be treated as income and taxed at your marginal or highest rate.