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Why selling your annuity could cost you £10,000

Retirees who want to cash in their pension will face large fees for advice, administration and health checks.

Why selling your annuity could cost you £10,000

Retirees planning to trade in their annuity for a cash sum should be aware the process could cost them thousands of pounds in fees and tax

From April 2017, those with an annuity will be able to sell the guaranteed income stream for a cash lump sum as part of the extension of pension freedoms to those who have already retired and purchased, what used to be, a non-refundable annuity.

While the idea of a straight swap for the annuity sounds like a great idea, retirees expecting to receive their original pension pot less the income payments they have already received, will be in for a shock.

The process won’t be that simple and it won’t be that cheap. In fact, it could cost as much as £10,000 in administration and advice fees and retirees, according to Andrew Tully, a retirement expert at insurer Retirement Advantage.

Those wishing to sell their annuity should also be prepared to go through health screening as insurers will offer less for an income stream from an unhealthy person who is likely to die sooner as the annuity income stops when the individual dies.

Tully set out two case studies that give an idea of just how much money a retiree will get for their annuity.

Case study 1

Sheila bought her annuity in 2013 aged 61. Due to high cholesterol and high blood pressure, Sheila had a life expectancy of just 18 years when she purchased it.

Due to her ill health Sheila was able to purchase an ‘enhanced annuity’ which pays out a better rate of income to those who have shorter life expectancy. In Sheila’s case the annuity rate on her pension pot of £60,000 was 6%, meaning she received £3,600 a year.

Since she purchased the annuity, Sheila’s health has deteriorated and her life expectancy is now 14 years.

According to Tully’s calculations, Sheila has £50,400 left of her pension based on 14 years of annual pay-outs of £3,600.

However, Sheila won’t receive that much as Tully said the cost of administration, health checks and advice, which will be mandatory for annuities worth over an as yet undecided amount, will cost £10,000.

This leaves £40,400 but Sheila won’t receive this amount either. She will have to pay income tax on the cash lump sum she receives which totals £9,563, leaving her with £30,837.

Case stud>y 2

John bought his annuity in 2014 aged 65. He has an average life expectancy of 21 years and didn’t look into buying an enhanced annuity. Instead he bought his annuity straight from the pension company without shopping around and received a 5% annuity rate on his pension pot worth £100,000, meaning he receives £5,000 a year in income.

Now John realises that he may have been able to get a better deal by shopping around and is wondering if the best solution is to just get his money back.

With 20 years of £5,000 a year pay-outs left, John’s ‘notional income remaining’ is £100,000, even though he’s had a year’s worth of income already.

Minus the £10,000 Tullly believes he will pay in costs, John is left with £90,000. Like Sheila, he will have to pay income tax on the lump sum, which will cost John £27,803.

This means he will receive £62,197, losing him 38% of the £100,000 he could receive as income.

Tully said those who are concerned that they were sold a poor value annuity when they retired ‘won’t necessarily get better value’ if they trade it in as it locks in poor value.

‘People are presenting [annuity sales] as a solution to poor value annuities sales but it won’t be,’ he said. ‘If anything it will exacerbate the poor value.’

7 comments so far. Why not have your say?

Geoff James2

Dec 29, 2015 at 09:39

Surely discounted cash flow would also be applied - Getting £100K over 20 years is worth far less than than receiving the same amount spread over monthly payments for 20 years. My rough calc suggests that £100K spread over 20 years is worth just £79K right now using a DCF of 3% which I think would be quite conservative for this type of calculation.

I think your cost of £10K is very conservative and suggests a flat fee. The charge is more likely to be £10K or 20% (or possibly 30%) whichever is higher

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Dec 29, 2015 at 11:48

It also assumes that they will not pay tax on their future annuity income (after state pension income etc).

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Dec 31, 2015 at 10:00

Geoff - you are partially right and the figures shown in this article are complete nonsense as they ignore the time value of money. At a discount rate of 3% (which as you say is conservative), the present value of £3600 a year for 20 years is £53,559. If the investor is looking to receive the same return as on other investments, a discount rate of 7% would bring this down to £38,138. For case study 2 the figures would be £74,388 and £52, 970 respectively. And this is before taking into account costs and taxes!

But the even bigger flaw is that you can only safely use average life expectancies if a large number of such second hand annuities are being bought. The smaller the number, the more the investor has to consider the very real prospect of losing all or part of their money. A 65 year old in average health has about a 1 in 8 chance in the UK of dying within the next 5 years. The risk of dying in the next 12 months doubles about every 8 years. For someone who is in worse health - and in receipt of a higher annuity as a result, the gradient will be steeper. The higher the risk for any investment, the greater the return expected. To bring it down to an individual life, how many year's purchase would you be willing to offer for one annuity of a 65 year old - nothing like the average amount!

This article will do little to dampen the unrealistic expectations of those who somehow think they can use a sale to recoup a poor original deal. They are likely to end up with a worse one. For most annuitants, in most scenarios, selling their annuity will be a very silly thing to do and it does not help when articles such as this are still painting a too rosy picture. Unless they are compelled to take part, I suspect annuity providers will not want to take part in repurchase - the cries of dashed expectations and claims of mis-buying will loom large.

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Dave Hill

Jan 02, 2016 at 06:59

Life is life. I've made bad decisions in the past, which I wish I could change. I can't so I accept what I've got. The same is for pensions. My financial advised I split it mine into 2. One a level paid monthly. The other to maximize total income is paid annually with a 5% increase each year in February. I'm not wealthy and both together are well below my my state pension.

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jolyon kay

Jan 03, 2016 at 10:20

Horshamtin is absolutely right,

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Frank Frank

Jan 03, 2016 at 13:47

People should stop trying to guess how long they expect to live. An annuity of £3600 pa is worth £103,000 now, because that is what you will get if you invest it in a property unit trust.

Of course that will leave you with the value of the fund when you die, but let that be your profit rather than the crook's who tried to rob you. If the crook does not like it, tell him to sod off. You have a tongue in your mouth, haven't you?

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Seb Toombs

Jan 25, 2016 at 09:16

Thanks for the tip for property trusts Frank Frank, I hadn't realised the captal invested and yield were both guaranteed. 3.5% for life plus return of capital sounds too good to be true! I shall have to fill my boots then with my defined benefit pension transfer.

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