Three consultation documents have been issued giving more detail about the proposed framework for a secondary market for annuities. The purpose of the secondary market is to allow individuals to assign or surrender annuities payable to them in return for a lump sum or another pension product. The Government estimates that up to five million individuals receive payments under pension annuities and that some 300,000 of these will choose to sell their annuity.
Having previously said "...annuities that are general scheme assets and not in the name of the individual will be out of scope", the HMRC consultation now appears to bring them into scope. The impact assessment for the proposals anticipates “some one-off burdens for pension schemes…including legal and consultation advice, training and familiarisation”.
When the introduction of the pension flexibilities was announced, there was criticism that it did not extend to individuals who had little choice but to buy an annuity with their pension savings. In the March 2015 Budget, the Government stated that it would create a secondary annuity market to extend the pension flexibilities introduced on 6 April 2015 to individuals holding pension annuities.
Following an initial consultation in March 2015 on the proposed policy framework around the secondary annuity market, more detailed consultation papers have been issued by HMRC, the Treasury and the Financial Conduct Authority (FCA). These consultations all closed during June 2016. The intention remains to have the framework up and running from 6 April 2017.
The current pensions tax rules treat the assignment or surrender of an annuity as giving rise to unauthorised payment tax charges, subject to certain exceptions (for example, assignments due to a pension sharing order). The HMRC consultation deals with the proposed tax framework for the new secondary annuity market.
Individuals will be able to assign or surrender annuities payable to them in return for one of three options:
- a lump sum;
- a flexi-access drawdown fund; or
- a flexible annuity.
Where an individual assigns or surrenders rights to payments under an annuity payable to him that were purchased with sums and assets from a registered pension scheme (including deferred annuities that have yet to come into payment), this will be treated as an authorised payment for pensions tax purposes provided that certain conditions are met.
The conditions vary depending on which option the individual chooses. For example, where the annuity proceeds are to be paid as a lump sum, the individual must have reached the normal minimum pension age of 55 (or, if lower, his protected pension age) unless he became entitled to the annuity on the grounds of ill health. Also, individuals must assign or surrender all of the rights under the contract - they cannot assign or surrender only some of those rights. The lump sum payment will be liable to tax at the individual’s marginal rate.
The new tax rules apply to annuities that were secured in respect of defined contribution or defined benefit arrangements – it does not matter whether the annuity is treated under the current tax rules as a lifetime annuity or a scheme pension, or represents rights in respect of a beneficiary (for example, a dependant’s annuity or a dependant’s scheme pension).
The changes will not affect ‘short term’ annuities (annuities bought from drawdown funds that are paid for no more than five years), nor will they affect annuities purchased with funds that did not originate from registered pension schemes.
The consultation states that although the new rules will apply only where the rights to receive payments under the annuity have been assigned by the individual who is receiving the payments, “it is intended that schemes should be able to assign annuities in their name to members”. Such assignments will be treated as authorised payments where:
- the annuity contract provides the benefits that would otherwise have been paid by the scheme; and
- other than the change of ownership, the annuity is unchanged following the assignment to the member who continues to receive the same payments under the annuity.
Although this is a change from the Government’s original stance, the consultation adds that the new tax rules are not intended to override any other contractual, (non-tax) legislative or other legal restrictions that prevent individuals from assigning or surrendering annuities that are not in their name.
It would appear from this that the scope of the secondary annuity market is widening – it now includes annuities securing rights from defined benefit schemes and may include annuities currently in the name of the scheme trustees.
Other points to note from the consultation include:
- Individuals who assign or surrender under any of the three options will be subject to the money purchase annual allowance although an exception is proposed for individuals surrendering or assigning low value annuities purchased before 6 April 2016 in return for taxable lump sums.
- A new benefit crystallisation event (BCE) will be introduced for lifetime allowance purposes, to apply where the assignment or surrender took place before the annuity has come into payment and the conditions for the new authorised payment have been met. The amount crystallised by the new BCE will be the amount of the proceeds paid to the individual.
- Any money remaining from a taxable lump sum received by an individual for assignment or surrender will form part of his estate upon death. Funds put into flexi-access drawdown will be treated in line with current drawdown rules so, for example, where that individual dies below age 75 with unused funds, those funds will be able to pass free of tax to any individual beneficiary.
- New information requirements will apply to insurers who issued the annuities being surrendered or assigned, to entities buying the annuities and to individuals assigning or surrendering their annuities.
This consultation contains draft secondary legislation amending provisions made under the Financial Services and Markets Act 2000 intended to make it easier for the FCA to apply tailored rules to firms participating in the secondary annuity market. The changes include proposals to create a new specified activity for:
- firms intending to purchase annuities or to act as intermediaries; and
- annuity providers intending to buy back annuities they have issued.
Firms will need to obtain new regulatory permissions before undertaking the activity.
The Government agrees that there are benefits in allowing annuity providers to “buy back” their annuity from an annuity holder. However, having identified a number of risks around consumer protection and firm solvency, it proposes that buy back should take place through an intermediary. It has asked the FCA to consider whether an intermediary requirement for buying back annuities would be necessary, and if so, whether there should be a threshold below which annuity providers can buy back an annuity directly.
The FCA is consulting on additional protections for individuals assigning or surrendering an annuity. Its proposals include:
- sellers should, at least once, and as early in the process as possible:
- receive the relevant risk warnings,
- be made aware of the possible existence, and where possible the likely amount, of charges and costs they may bear in selling their annuity income,
- be made aware of the possibility of taking advice, or using the Pension Wise guidance service, and be encouraged to use such services,
- be made aware of the possible legal requirement for them to take advice and the possible need to obtain consent from contingent beneficiaries, and
- be encouraged to shop around for better quotes for their annuity income;
- all quotes made to the seller should be presented net of the firm’s estimated costs where possible and should be accompanied by a quote of the replacement cost of the annuity income were it to be bought new on the open market; and
- sellers will be able to complain to the Financial Ombudsman Service and seek redress from the Financial Services Compensation Scheme, subject to satisfying the eligibility criteria.
If the implementation date of 6 April 2017 is to be met, the Government has less than ten months in which to consider submissions made to the consultation, prepare its own response and deliver the legislative changes needed. The view that occupational pension schemes would be largely unaffected by the proposals is proving unfounded. However, the changes may also present schemes with further opportunities to manage their liabilities. While we await the consultation outcome and practical detail of how the proposals will work, trustees may wish to check which annuities their schemes currently hold and whether the scheme rules and/or the annuity contract impose any restrictions on assignment.