Guest blog from Malcolm Small, Executive Chairman, Retirement Income Alliance, 30th October 2016
We've spent a lot of time talking about 'pension freedoms' since they came in last April. In case you've missed it, this basically means you no longer have to buy an annuity with your pension payout.
Of course, as with all changes in policy, there were some people who 'just missed out' on being eligible for the new freedoms. So they purchased an annuity where, had they held out for a few weeks or months, they would have had a number of different choices for their retirement income.
To appease this group, the government floated the idea of a 'secondary market' where they could re-sell their annuities for a cash value – something that is not usually allowed. This idea has now been abandoned and, while I feel for the few in this situation, the logic behind the decision is in other ways designed to protect the many – here's why.
Poor re-sale value
First, any re-purchase of the annuity would have to take into account income payments already made, knocking them off the value offered with, presumably, an interest bill of unknown quantity—or in other words, the opportunity cost to insurers—applied retrospectively.
Then the bill for any commission paid would need to be deducted, as well as the profit margin for the ceding insurer. Add in transaction costs to the acquiring insurer, and the current and likely future dire state of gilt yields on which annuities are based, and people thinking of selling their annuities on the open market may have been shocked by the paucity of the figures quoted. For most people, the re-sale value may not have in fact been enough to make it worthwhile.
Jeopardises the annuity model
Annuities are provided by insurance companies, who offer a 'guaranteed' (insofar as that word can ever extend to a financial product) regular income in exchange for your pension fund. A re-sale market would have destroyed their business model.
If you cannot know how much of your annuity book will leave you, at what point and to whom, how can you offer a price? Sure, you can model some assumptions, but this was uncharted territory. This means by introducing a re-sale market, the government would effectively be harming the product for any investors who do still wish to buy them under the pension freedoms law.
How would the market operate?
Such transactions have risk written all over them and industry participants from advisory firms to brokers made it clear they were not keen to participate. Given the pricing and other regulatory complexities, it is nearly impossible to imagine how such a market would operate and who would do it.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Malcolm’s views are his own and do not constitute financial advice.