Creating a secondary annuity market: the government consults on the tax framework

The government has issued a consultation on the detail of the tax framework for the proposed secondary market which will allow people to sell their annuities in certain circumstances. This follows a previous consultation on the policy framework for a secondary annuity market in 2015, the details of which we discussed here.

This consultation is open until 15 June 2016, and the intention is to implement the conditions allowing a secondary market for annuities in 2017. The government intends to make necessary changes to tax legislation by means of secondary legislation which will be published for consultation later this year, with a view to having effect from 6 April 2017. Further changes may be included in the Finance Bill 2017.

HM Treasury has also issued a consultation on draft legislation to create three new specified activities applying to any person wishing to operate in the secondary annuities market, and the FCA has published a consultation paper setting out its proposed rules and guidance for the secondary annuity market. In this update we focus on HMRC’s consultation on the tax framework, but include a summary of some of the main points in the FCA’s consultation paper at the end.

The intention behind the creation of a secondary annuity market is to allow individuals who have bought an annuity but who wish to swap this for a taxable lump sum or a more flexible source of income, to do so.

HMRC consultation on the tax framework for a secondary annuity market

In order to allow for the creation of a secondary annuity market it will be necessary to remove tax rules that currently deter individuals from assigning or surrendering their rights to receive income payments under pension annuities. Subject to meeting certain conditions, the government is proposing that unauthorised payments will not arise where individuals assign or surrender annuities payable to them that were purchased with sums and assets from a defined contribution or defined benefit registered pension scheme, including deferred annuities that have yet to come into payment. This will apply regardless of whether it is a lifetime annuity or a scheme pension, or represents rights in respect of a beneficiary under an annuity that is a dependants’ annuity, a nominees’ annuity, a successors’ annuity or a dependants scheme pension.

The new tax rules will provide individuals with the option to assign or surrender their annuity for the following:

• A lump sum.
• A new flexi-access drawdown fund.
• A new flexible annuity. 

There will be certain conditions that must be met in order for the payment to be authorised, which will include:

• Individuals will have to assign or surrender all of their rights under the annuity contract – it will not be permitted to assign or surrender only some of those rights.
• The payment will only be authorised where it is made by the annuity purchaser to the person selling their annuity, or to their personal representatives. Payment cannot be made to a contingent beneficiary of the annuity (for example, a spouse).
• Where the payment is made as a lump sum, it will need to be made as a single lump sum, rather than as a series of payments.
• Subject to certain exceptions in the case of deferred annuities, or members who have a protected pension age or who retired on grounds of ill health, the new rules will only apply where at the time of the assignment or surrender, the person receiving payment has reached age 55.
• To protect against abuse, the payment for the annuity will not be an authorised payment where it is assigned to a person or entity which is connected to the seller of the annuity, or where the assignment or surrender is part of a tax avoidance scheme.
• Where surrender or assignment is for rights under a flexi-access drawdown fund, there will be specific provisions about how this transaction will affect the individual’s lifetime allowance. 

Where the lump sum option is chosen, the proceeds will be treated as pension income liable to tax at the member’s marginal rate. As expected, it will not be possible to take a tax free lump sum.

Where the flexi-access drawdown or flexible annuity options are chosen, the income subsequently drawn from the flexi-access drawdown fund and income from the flexible annuity will be subject to income tax in the usual way.

Whichever option is chosen, individuals receiving payments can expect to be subject to the money purchase annual allowance (currently set at £10,000). However, where the taxable lump sum option is chosen, this will be subject to a threshold so that those surrendering or assigning a low value annuity purchased before 6 April 2016 will not be subject to the money purchase annual allowance. The government is going to develop an appropriate definition of low value annuities for this purpose.

There will be various new information requirements on insurers who issued the annuities being surrendered or assigned, the individual who has the annuity and the entity purchase the annuity.

FCA consultation paper on rules and guidance for the secondary annuity market

The FCA consultation paper sets out the proposals that will apply to the three new regulated activities that are to be created in relation to the secondary annuity market. The proposed changes to the FCA handbook are intended to help ensure that consumers have an appropriate degree of protection should they decide to sell their annuity income income, addressing key risks to good consumer outcomes. Amongst other areas the proposals include:

• In order to help consumers judge the value of their annuity income, it is proposed that buyers and brokers will be required to present their offer alongside the ‘replacement cost’ of the annuity income, if it were to be bought new on the open market.
• Requiring firms to provide risk warnings to the annuity seller, at the earliest opportunity, recommending that the seller seeks regulated advice or guidance from Pension Wise. Firms will also be required to recommend that sellers shop around.
• A requirement that brokers must set out their charges upfront and agree them with the consumer selling their annuity, rather than being paid commission from firms acting as buyers.
• A proposal that annuity providers will only be able to recover reasonable costs when charging to facilitate annuity income sale, and the sale of annuity income will fall within the scope of both the Financial Ombudsman Service and the Financial Services Compensation Scheme.