It is understandable that the 5 million or so people who have already bought annuities feel left out of the new pension freedoms. But the government’s solution – allowing retirees to sell their annuity for a cash lump sum – is destined to leave many pensioners short-changed and some facing a retirement in poverty.
To extend these freedoms to annuity-holders the government is creating an annuity resale market that is guaranteed to be one-sided. If you pit hard-up pensioners desperate for cash against sophisticated financial organisations with deep understanding of life expectancy and financial markets, it is obvious who is going to come out on top.
The cash amounts institutions will offer pensioners for their annuities will at first glance look generous when compared with the monthly income being paid. But they are bound to be a fraction of what it would cost to buy that income stream on the market.
Any pensioner who thinks they will be able to cash in their annuity for what they paid for it – less the income already received – is in for a rude awakening. Experts are predicting that pensioners will in the very best circumstances get between 20 to 30 per cent less than the true value of the income they are giving up, with a number of factors making these transactions very expensive.
It may be unpleasant to think about it, but the sooner the pensioner dies, the sooner the annuity stops paying out. So institutions offering to buy second-hand annuities will have to factor in the likelihood that pensioners with life-threatening conditions will be more likely to want to sell their annuities for cash. Marketing costs, profit margin and the costs of sale – a medical examination will be essential to protect the interests of purchasing companies – will also add to the frictional costs of the process.
For many pensioners who bought poor value annuities in the first place, selling them on will simply mean compounding one bad decision with another. While they may get 20 to 30 per cent of the true value of the annuity, many people did not buy at true value in the first place.
An investigation by the Financial Conduct Authority, the City watchdog, found that eight out of 10 annuitants who did not shop around for the best deal lost out, missing out on an average of £1,500 as a result. It is not inconceivable that having lost out to the tune of 25 per cent on the way into their annuity contract, pensioners could lose another 25 per cent on the way out.
Then there is the equally serious risk that retirees will run out of money within a few years of receiving their cash payoff. Annuities insure the holder against ‘living too long’, paying an income right up to the day they die, however far into the future that may be.
We know that people underestimate how long they are likely to live, and therefore how valuable to them their annuity actually is. People understand even less well the chance that they could live quite a bit longer. A 65-year-old male has a one in four chance of reaching 94 – while a quarter of women of that age will make it to 97, according to the Office for National Statistics. The chances of a cash lump sum lasting 30 years are slim to say the least.
The government is clearly concerned that people who cash in their annuities will look to fall back on the state. That is why it plans to exclude those on means-tested benefits such as Pension Credit and Housing Benefit from being able to cash in their annuity. It has also made clear it will withhold benefits from anyone who wilfully spends their annuity cash and leaves themselves without enough to live on.
This resale annuity plan creates a serious risk that pensioners could in future be forced to live on less than means-tested benefits. Surely reforming the existing flawed annuity sales process would be a better way forward.