The government and the City watchdog are underestimating the risks posed to pensioners by controversial plans to let retirees cash in their annuities, a new report has warned.
Pensioners will be able to sell their income guarantees in exchange for cash lump sums when a secondary market in annuities is launched next year.
The plans were first set out in the 2015 Budget and proposed rules were published in April by the Financial Conduct Authority (FCA), tasked by the government with creating a regulatory framework for secondary annuities.
HMRC and the Treasury have also issued consultations, but opposition to the plans continues to strengthen amid fears of pensioners being ripped off and left penniless in retirement.
There are “fundamental barriers to effective competition for secondary annuities that are likely to prevent pensioners getting a fair deal”, according to a new report from the Open University Business School, which calls for more robust protection for consumers considering selling their annuities.
The plans, pitched by the government as “extending” the so-called pension “freedoms” to people who had retired before they took effect last April, would allow existing annuity holders to sell their contract to the highest bidder in exchange for a lump sum.
The FCA said that while secondary annuities may give some people welcome flexibility, “we believe consumers selling their annuity income could be exposed to significant risks”.
But the government and the regulator have both underestimated the scale of the problems that need addressing if the market is to work, according to the report.
It said there was a “a real risk that there will be no functioning market at all when the laws come into force next year”.
A lack of cheap-but-effective advice and the risks specific to vulnerable pensioners are among a number issues that need to be tackled if significant detriment is to be prevented.
One problem is that, unusually, consumers will be selling to firms, with the latter acting as the price setters. The market will therefore only function properly if there are several firms competing to buy contracts and if pensioners shop around for the best price they can get.
Evidence from the existing annuity market suggests many are unlikely to do so, however, reducing effective competition and leaving sellers with poor value deals.
Even if the market is efficient and competitive, sellers will lose up to 30 per cent of the value of their annuity to transaction and administration costs, according to the report,
“While many pensioners may prefer to purchase a drawdown pension at retirement, taking the risk that the money will run out if they live a long time in order to pass on some of the money to their family if they do not, it is extremely unlikely that many will be better off selling their annuity to purchase one, incurring a 10 to 30 per cent loss compared to having entered drawdown at retirement,” it said.
Sellers also face the prospect of shock tax bills. The Treasury is set for an estimated £960m windfall in the first two years of the secondary annuity market because the lump sum paid to sellers will be treated as normal income in the year they receive it. The effect in some cases will be to drag the seller into a higher tax bracket.
A quite different risk to pensioners is highlighted today by former pensions minister Steve Webb, who warns that some older retirees in the British Steel Pension Scheme could lose more than £10,000 if the government goes ahead with a proposed rule change.
It has suggested changing legislation to allow the troubled scheme to cut costs by increasing payments to members in line with the consumer prices index (CPI) measure of inflation rather than the retail prices index (RPI), the basis currently used and which is higher.
But Webb, now director of policy at Royal London, claims that members who completed their service before 1997 could have their payouts entirely frozen under the suggested rule change, while many who did most of their service before 1997 would get only very small increases.
An 80-year old pensioner receiving £100 a week from the scheme could lose over £10,000 over the next decade if the proposal gets the green light.
“This is not simply a case of switching from one inflation measure to another. Many thousands of older steel workers and their widows could see their pensions largely frozen for the rest of their life if these plans go ahead, with losses running into thousands of pounds,” said Webb.
“This potentially huge impact, buried in the small print of the government’s consultation document, highlights the way in which rushed legislation can all too often have unintended consequences.”