People have much greater freedom and flexibility over their pension since new rules were introduced in April. These new rules allow people over age 55 to take lump sums or income from their pension, although any amounts over and above the tax-free cash sum – which is usually 25 per cent of their pot – are subject to income tax.
However, the freedoms didn’t apply to those who had bought an annuity before the rules were introduced. The government is now moving to change this, allowing people to exchange their annuity income for a cash lump sum from April 2017.
This process does not means the annuity stops existing. Rather, the income will be paid to a third party – such as an insurer or pension scheme – instead of the original customer. In return, the third party will give the customer an immediate cash sum, which will attract income tax.
The lump sum the purchaser is willing to pay will be based on how much income the annuity is currently paying out, and importantly, the customer's life expectancy . This means taking into account the customer’s current health and lifestyle to try and estimate how long the individual will live, as this will determine the likely income stream remaining.
Exchanging income for a lump sum may be a good decision for some people, particularly if they need to pay off debts or if their circumstances have changed dramatically since the original purchase. But there are significant risks, with the likelihood that people may get a poor outcome.
For example, many people don’t hunt for the best deal when buying an annuity, meaning they get a poorer income than they could have. Cashing in a poor-value annuity will not right the original wrong.
The positive news is the process for trading an annuity will make sure people shop around for the best deal.
Extending pension freedoms to the five million people who currently receive an annuity income may be appealing to some people. But, and this is a big but, we need to create a market which protects consumers from poor value and from scams, helping them work out if they are receiving a good deal.