One of the ideas floated by Steve Webb around the time of Pension Freedoms, was the ability to sell your annuity to a provider for a cash lump sum. There is a consultation currently going on, but I struggle to see how this is likely to be beneficial for people in the years to come.
As IFAs we have been approached by a client who would like to sell his annuity for a cash lump sum. We have explained that the enabling legislation is not in place and that there is no market to match buyers and sellers, but the client is now wanting us to approach the provider to see if there could be a buy-back at some point.
At this juncture, I think it would be valuable to look at the maths involved in the annuity in question.
The annuity was established on the 6th January 2006, when the client was 60, purchased for £101,181.20 and provides £9,683.64 per annum for life, so this is a yield of 9.57% per annum. So far, the annuity has paid out 806.97 x 113 months = £91,187.61, so in just over 1 year’s time, the annuitant will have received back all of his original cash.
The annuity provider is on the hook for £9,683.64 every year until eventually the annuitant drops dead and cannot spend his money any more, so the annuity provider’s liability is uncapped.
If the annuitant dies in December 2028, at the age of 82, he will have received a total of £222,723, which would be the equivalent of his initial £101,181 and 3% interest on his capital as it was eroded.
If he dies at age 85, he will have received £251,775, which would be all his initial money plus 6% on the remaining cash as it was spent.
If he makes it to age 90, which is not inconceivable in this day and age, he will have been given the equivalent of 8.4% on his invested money as he spent the principal.
Whether the client lived months after his annuity was set up or decades past his 100th birthday, the annuity provider is contractually bound to pay the income of £9,683.64 and stand any loss. Almost all of the investment risk passes from the client to the annuity provider, so I would suggest that even 3% is a reasonable return on the client’s money.
For the annuity provider, how would you value the buy-out of the obligation to pay the client nearly £10,000 every year until he died? Actuarial tables suggest that the client now has an average life expectancy of 83.46 years, (http://www.riskprediction.org.uk/adj_lifeexp.php), so a reasonable expectation of further expenditure is 14.46 years x £9,683.64 per year, giving a likely cost of £140,025. Discount this down for the early payment and offer the client about £90,000 to go away?
If the client is healthy, I would suggest that for the annuity provider this is good business as all of the longevity risk has been passed back to the client. People are generally living longer, so the provider must anticipate paying out annuities longer.
For the client, I expect he would consider that all his Christmas’s had come at once, but this is one of those occasions that I would caution that you should be careful what you wish for. If the client dies in the next 14.46 years he, notionally, will be ahead of the financial game; but if he keeps living he will undermine any advantage he had. He could find himself wishing he was dead for monetary purposes!
Annuities are not for everyone; if you can accept some investment risk and have a fund large enough to keep the fixed charges at bay, a drawdown plan may be a better, more flexible choice. But annuities are a de-risking measure, passing investment and longevity risk to the provider. How complicated do you really want your retirement?
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