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Second-hand annuity sales scrapped: what now for your retirement options?

The government has scrapped its plan to let you sell your annuity. What are your options now?
November 3, 2016

The government has scrapped its plans to allow pensioners to sell their annuity in return for a cash lump sum due to a lack of potential buyers and concerns over consumer protections.

The contentious plan for a secondary market in annuities was first mooted by the government in March 2015 as a way to give more freedom to pensioners locked into low-value annuity deals. But critics argued that assessing the cash value of complicated annuity products would be difficult and said buyers would be hard to find.

Now the government has rowed back on its plans, concluding that “the consumer protections required could undermine the market’s development” and that “there will be insufficient purchasers to create a competitive market”.

Hargreaves Lansdown had already said it would not take part due to concerns that selling annuities would not be in the best interest of customers. The broker said in September that key risks included customers incorrectly estimating their life expectancy and not planning adequately, disproportionately high costs for sales of small annuities and the difficulty faced in assessing value for money for the income customers were giving up.

 

When might an annuity make sense?

Annuities have picked up a bad reputation in the past ten years as rates have come crashing down. The income offered for pension pots has fallen dramatically in the past ten years as bond yields have declined.

But there might be times when an annuity makes sense. Annuity rates have risen 3.4 per cent since their low of four weeks ago and there have been seven annuity rate rises since 21 September 2016. According to Hargreaves Lansdown, a 65-year-old smoker with a £100,000 pot could now take home £168 more per year of non-increasing income per year compared with four weeks ago as a result of changing rates.

Patrick Connolly, chartered financial planner at Chase de Vere, says: “On a historic basis the rates are terrible but you have to bear in mind that we are in a low interest rate environment and it looks like low rates will be around for some time.

“People in retirement need to have secure income to cover their basic living cost. That could come from state pensions, from defined benefit pension schemes and from lifetime annuities.” He says a good way to incorporate annuities can be to mix and match with other pension options by using part of your pot to buy an annuity and cover your basic income needs.

According to Nathan Long, senior pension analyst at Hargreaves Lansdown: “The direction of annuity rates is uncertain, but two things are clear. You will get more income buying an annuity today than you did four weeks ago, and shopping around for the best income remains critical especially as now three in four people can get higher rates by disclosing any health conditions or lifestyle traits. For those approaching retirement taking another look at what you could get will be time well spent.”

  

Your retirement options and the tax implications

Since April 2016, pensioners have been given far greater freedom over their pensions than ever before due to the new pension freedom legislation unveiled by the last government. Working out which is right for you will involve calculating the income you need and the likely tax you will have to pay on any income you take from your pot. The main options open to your aged 55 are to leave your pot as it is, buy an annuity, move it into income drawdown, take lump sums from the pot, take it all at once, or opt for a mix of the above. Bear in mind, though, that taking hefty chunks could leave you with a sizeable tax bill as only the first 25 per cent is tax-free.

Income drawdown: Also known as flexi-access drawdown, this gives you the option to take 25 per cent of your pot tax-free and move the rest into income-generating funds. Managing your investments carefully is crucial here, as taking too high an income or an unsustainable yield will erode the capital value of your pot. The income you take is taxable and bear in mind that, although many platforms and Sipp providers do offer the full range of options, you may have to pay a set-up fee to move into flexi-access drawdown. If you die before age 75, any money left in your drawdown fund passes tax-free to your nominated beneficiary whether they take it as a lump sum or as income. The beneficiary must then take those payments within two years or income tax will have to be paid. If you die after age 75 and your nominated beneficiary takes the money as either income or a lump sum they will pay tax at their income tax rate.

Lump sum withdrawals: You could also choose to leave your pension pot where it is and take lump sums from it as and when you need, taking 25 per cent tax-free cash each time. This is good for those who don’t need their full pot yet and aren’t reliant on their pot for a consistent income but might want periodic lump sums. The remaining amount remains invested, ensuring that the value and future income is not secure, but unlike converting the amount into drawdown, it is not switched into different income-orientated funds. Bear in mind that taking a large withdrawal from your fund could push you into a higher tax bracket - the first 25 per cent is tax-free, but anything above that will be added to your income for the year.

 

What to think about when approaching retirement

Work out your income needs: Mr Long says: “What are your aspirations for retirement? Most people look at what their minimum requirements are to cover their essential living costs and then have a higher, preferred income level.

Work out your retirement incomings: Retirement income can come from many sources. Work out what you will be receiving and whether it matches your income needs. Consolidating pensions ahead of retirement will make keeping track of your plans easier. For more on how to consolidate pensions see our article earlier this year.

Consider a mix and match approach: – Mr Long says: “Your essential needs should ideally be met from guaranteed forms of income such as an annuity or state pension. Above this you can afford to risk with the nice to haves and luxuries. If current annuity rates don’t appeal you can spread the risk that you buy at the wrong time by splitting your pension.”

Understand the risks of drawdown: Leaving your money invested means you could lose value as well as gain. Hargreaves Lansdown recommends drawing £1,000 a year for every £30,000 of pension as a rough guide in order to ensure your pension does not run out.

Understand what you will be taxed: Withdrawals will be added to your income in that tax year and subject to any further income tax. Large withdrawals could result in you being pushed into a higher tax bracket.

Leave your pension untouched for longer: Mr Connolly says: “At age 55 most people won’t be taking anything from their pension. Just because you can access it, doesn’t mean you should and even when you do want to draw an income, don’t assume that you should take it from your pension. You might be better taking it from Isas, especially if you are still working because Isas are tax-free.”

Check that your provider offers the freedoms you want…: Although pension freedoms have now been in place for more than a year, there are still discrepancies when it comes to the level of freedom offered by pension providers. There is no requirement for any pension provider to offer flexi-access drawdown. If your current pension provider is no going to offer it you will need to find out if you can transfer your benefits elsewhere (there is likely to be an exit fee for doing so too).

…And what it will cost you: Different providers charge different amounts for setting up options such as flexi-access drawdown. For example Barclays Stockbrokers charges a one-off £75 fee to clients setting up flexi-access drawdown and paying any lump sum benefit.

 

Sipp platform charges for drawing income

Annual and one-off fees specific to income drawdown and lump sum withdrawals Drawdown set-up costsAnnuity purchase charge 
Alliance Trust Savings Regular income payments (income drawdown, lump sums or one-off income): £21.25 + VAT p. month. One-off lump sum charge - £40 + withdrawal.Free150 external
AJ Bell YouinvestRegular income drawdown payments or regular lump sum payments: £100 p.a. One-off payment of of tax-free lump sum, income payment, lump sum payments: £25 Free £150
Barclays Stockbrokers Regular income (flexi-access, income drawdown): £100 p.a. One-off payments of lump sum: £75£75 to set up income drawdown and pay lump sum benefits £75
Charles Stanley DirectNo fee for regular drawdown. Irregular income payment £25 + VAT£150+ VAT to move into drawdown£150 external 
Bestinvest Regular income drawdown : No annual charge for portfolios valued >£100k. £100 p.a. for portfolios valued below £100k. One-off payments £25Initial calculation fee between £90-100 depending on Sipp size£75 through Bestinvest, £150 external 
Fidelity Personal Investing NoneFreeNone
Hargreaves Lansdown No charge for regular income payments or one-off payments FreeNo charge if purchased via Hargreaves, £150 + VAT external

Source: Company websites, as at 2.04.16