HM Revenue and Customs (HMRC), the Financial Conduct Authority (FCA) and HM Treasury have all recently issued consultation papers on the secondary annuity market which is due to ‘go live’ in April 2017. The consultations set out in more detail the proposed tax rules which will effectively create the secondary annuity market and the regulatory framework that will apply.
Currently, individuals who have bought an annuity with funds from a defined contribution pension plan are effectively “locked in”, as they face an unauthorised payment tax charge of up to 55% (or 70% in some cases) if they were to assign their annuity to a third party.
In Budget 2015, the Chancellor announced that the Government would change the tax rules to remove the barriers which currently deter annuity holders from assigning their annuity income to a third party in return for a lump sum. Immediately following this, HM Treasury and the Department for Work and Pensions issued a call for evidence setting out in high level terms how this market might operate.
HMRC, the FCA and HM Treasury have recently issued the following further consultation papers which provide more detail on this:
- HMRC consultation – Creating a secondary annuity market: tax framework
- FCA consultation – Secondary Annuity Market – proposed rules and guidance
- HMT consultation - Creating a secondary market for annuities – secondary legislation
The new tax framework
Under the new tax rules, it is proposed that where an individual assigns or surrenders an annuity after reaching minimum pension age (currently age 55) the proceeds could be:
- paid as a single cash lump sum to the individual selling the annuity
- transferred into a flexi-access drawdown fund, or
- used to purchase a flexible annuity (a new type of annuity which may go down as well as up).
Under option 1, the whole amount received would be taxed at the individual’s marginal rate and there would be no option for an individual to split the lump sum payment in order to avoid being pushed into a higher income tax band.
Under options 2 and 3, the proceeds transferred or used to purchase a flexible annuity would not be subject to income tax, would not be eligible for pensions tax relief, would not count towards an individual’s annual or lifetime allowance, and would not trigger entitlement to a tax-free lump sum. Amounts drawn down and income received from a flexible annuity would then be taxed in the usual way.
As things stand, there will be no scope for an individual to combine the three options above.
The current unauthorised payment rules will be overridden on assignment or surrender subject to a range of conditions being met. These conditions will vary depending on how the proceeds are used.
Individuals who assign or surrender an annuity will in most circumstances be subject to the money purchase annual allowance following receipt of the lump sum or payments from the flexi-access drawdown fund or flexible annuity into which the proceeds have been paid.
Funds put into a flexi-access drawdown fund will be treated in line with the new tax rules recently introduced for drawdown funds on death.
These new options will only apply to annuities held in an individual’s name and individuals will not be able to assign pension income from a defined benefit plan. However, HMRC’s consultation paper envisages circumstances in which annuities purchased “in the name of a scheme” under both defined contribution and defined benefit arrangements may be assigned to a member to enable them to take advantage of these options. Whilst we do not believe that this statement applies to bulk annuities held by defined benefit plans it is not clear precisely what circumstances HMRC has in mind here. We will be seeking clarity on this in our response to the consultation.
Where an annuity has been assigned, it is proposed that the annuity payments will no longer be treated as pension income in the hands of the buyer, but will instead be treated as trading income, investment or other income, depending on the nature and business activities of the buyer. The Government’s view of the likely tax treatments for certain buyers is set out in the consultation paper from HMRC.
If a registered pension scheme were to purchase annuity income (either directly or through an intermediary) the Government has indicated that the income from these annuities would not be taxable.
Regulatory regime and consumer protection
In its consultation, the FCA recognises the “significant risk of poor outcomes for consumers in the secondary annuity market”. In order to mitigate these risks the following measures are proposed:
- risk warnings – firms engaged in the secondary annuity market will be required to provide individuals with suitable risk warnings when they are first contacted by them about a proposed sale.
- disclosure – buyers will be required to disclose the likely amount of costs and charges that may be incurred when selling an annuity, supply a quote net of the firm’s costs and include by way of comparison a quote of the cost of replacing the annuity income in the open market today.
- financial advice requirement - an individual looking to sell an annuity above a certain value (yet to be determined) will be required to seek appropriate financial advice before proceeding with the sale. Firms will also be required to recommend that an individual takes advice, even if they are not required to do so, when first contacted by the seller.
- guidance - access to Pension Wise will be extended to sellers and contingent beneficiaries in the secondary annuity market. Firms will be required to recommend that sellers and contingent beneficiaries make use of this.
- regulated activities - there will be three new regulatory activities related to the operation of the secondary annuity market – buying annuity incomes, buying back annuity incomes and acting as a market intermediary. Participants will need to obtain these new regulatory permissions before undertaking any of these activities.
- contingent beneficiaries consent – annuity providers will (where legally required) need to make reasonable efforts to obtain consent from relevant contingent beneficiaries prior to facilitating an annuity income sale.
- Financial Ombudsman - Sellers will have access to the Financial Ombudsman’s Service to resolve disputes arising in connection with the sale of an annuity.
There are no real surprises in these latest consultations on the secondary annuity market. At this stage it is still unclear how many individuals will want to take advantage of this new flexibility or who the buyers will be.
Although it may be in some people’s interests to sell their annuity there remain, as the FCA recognises, significant risks of consumer detriment in this new market even with the proposed regulatory and consumer safeguards that will be put in place. Therefore, participants in this new market will need to proceed with caution and take steps to mitigate the risks of future mis-selling claims.