October 2016 update
Plans to allow retired workers to reverse their pension arrangements and receive a cash lump sum have been scrapped.
Here’s what you need to know about the decision to abolish plans for a so-called secondary annuity market.
The Government has confirmed plans to allow millions of people to cash in their annuities.
The scheme was originally proposed by Chancellor George Osborne in last March’s Budget, and the Treasury has now revealed that annuity holders will be able to trade in old policies from April 2017.
At present, it is technically possible to sell an existing annuity, but those who do so face punitive rates of tax on the proceeds.
Read more about the pros and cons of annuities
Around five million people are thought to be current annuity holders and the Government has said it expects most of them to hold on to their annuities rather than opt for a lump-sum payment.
The change in rules on annuity sales is being introduced in response to new pension freedoms that came into effect in April 2015.
These freedoms effectively mean that anyone who reaches retirement is no longer forced to buy an annuity, as has been the case for the majority of retirees in recent years.
How do annuities work?
An annuity is a financial product that exchanges most or all of an individual’s pension savings for a guaranteed monthly payment for the rest of their life.
This payment can be linked to inflation to help it maintain its value (although inflation-linked annuities are more expensive) and people with certain medical conditions can get higher payments due to their shorter life expectancy.
Find out more about unlocking your pensions at 55
What are the downsides of annuities?
Over recent years, life expectancy has risen and interest rates have fallen. These factors have driven down returns on annuities and many people who have been compelled to buy an annuity have felt they have got a poor deal.
This is one of the reasons the government has reformed the pension system this year: the changes allow people more freedom to choose how their savings can be used to provide for their later years, for example by leaving money invested in the stock market or by investing in buy-to-let property.
There are, however, around five million current pensioners who bought annuities before the reforms came into effect in April 2015. It is this group that this week’s proposals are targeted at.
Why would someone sell an annuity?
Analysts expect that people who receive only a small monthly income from their annuity might be more inclined to sell: they might think that the lump sum they receive could be more useful, for example for one-off spending such as on home improvements.
Such people might have sufficient state pension or other income to fall back on, and may think that the little annuity income they currently receive does not have a significant impact on their finances or lifestyle.
Will changes to the state pension system affect you?
How will annuity sales work?
The Government says that it will work to ensure that people do not end up making bad decisions when it comes to selling an annuity.
For example, it will be possible to sell an annuity back to the company which provided it: but this will have to be done via a third party to ensure the seller shops around to get the best deal.
Sellers will be able to provide details of their annuity and will be given quotes for what size of lump sum they will be entitled to in return for giving up future income. The Treasury says any lump sum received will be taxed as income at the seller’s marginal rate.
Those who are considering selling will be able to get free, impartial advice from the government-backed Pension Wise service. Sellers of higher-value annuities may be forced to take independent financial advice.
Finally, intermediaries and the companies which buy annuities will be officially regulated – this means that it will be easier for sellers to get a fair deal and to seek compensation if they are treated unfairly.
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What are the potential downsides of selling an annuity?
While annuities have fallen out of favour recently, they still can have a lot to offer. Primarily, they come with a guarantee that the holder’s money will never run out while they are still alive.
Anyone who sells their annuity loses this guarantee. And if you have an inflation-linked annuity, you could be risking giving up even more in future. Although inflation is low at present, were it to rise sharply in future, this kind of annuity would offer valuable protection.
It is not yet clear what would happen to certain means-tested benefits such as pension credit as the result of someone selling an annuity. And there are potential tax implications of selling: depending on what other income is received in the relevant financial year, the lump sum could push the seller into a higher income-tax band.
For more useful information, browse our money articles