Nominees' annuity: what is it, how does it work, and what's the catch?

Full transcript

This is what is said in the video, with the figures written as numbers. Timestamps open the video at that point. The narration uses a digital clone of Steve Hunt's voice. The words are his own.

0:00Today's question

Today's question... the nominees' annuity. What is it, how does it work, and what's the catch? I'm Steve Hunt, a Chartered Insurance Risk Manager a Trust and Estate Practitioner, and I started my career in 1980.

0:24What is a nominees' annuity?

So what exactly is a nominees' annuity? A nominees' annuity is a joint life annuity, where, instead of the second life being a spouse, civil partner or common-law partner, the second life is a child or grandchild, or anyone else that you nominate, to be the second life. There is one big caveat or warning on the nominees' annuity right now. The second life, the nominee, currently needs to be over the age of 40.

That's not a legal requirement. Legally, the nominee could be any age, even 2 days old. But at the moment, the insurers who issue these nominees' annuities will not accept a second life, the nominee, if they are under the age of 40.

The nominees' annuity came about as a result of George Osborne's pension freedoms, so they have been available for over a decade now, just never taken up by the insurance industry, as far as I am aware, until now. The legal definition of the nominees' annuity is in the black letter

1:30The legal definition

law: the Finance Act 2004, Schedule 28, paragraph 27AA(1), inserted by the Finance Act 2015. In the Act's own words: For the purposes of this Part, an annuity payable to a nominee is a nominees' annuity if, either, it is purchased together with a lifetime annuity payable to the member, and the member becomes entitled to that lifetime annuity on or after 6 April 2015.

Or, it is purchased after the member's death, the member dies on or after 3 December 2014, and the nominee becomes entitled to the annuity on or after 6 April 2015.

That's the black letter of the law, but only the first definition escapes IHT: an annuity payable to a nominee is a nominees' annuity if it is purchased together with a lifetime annuity payable to the member, and the member becomes entitled to that lifetime annuity on or after 6 April 2015.

2:45Why is it in the 2004 Act?

It's a little confusing, isn't it. When I first researched this, I was confused too. The nominees' annuity appeared in the 2004 Act, but I knew it came from Osborne. So why was it in the 2004 Act? Because it was Osborne's Finance Act 2015 that inserted the additional wording into the Finance Act 2004.

So even though it appears in the 2004 Act, it was not a thing, until Osborne's 2015 Act put it there. Follow me so far? I recently wrote a detailed article about nominees' annuities on LinkedIn, which you can see on screen and in the description below.

3:36How it works: two real quotations

So how exactly does a nominees' annuity work? I will use the figures from that LinkedIn article, because they were real, actual quotes from the actual nominees' annuity providers. For that article, I asked all the annuity providers the nominees' annuity question. The question, in plain English: Mr Miggins is 75 and single. He wants a lifetime annuity that carries on paying his daughter Amy after he dies.

Will you write it, and how young can Amy be? And here are the answers. The annuity provider, Just, was a big, positive yes. And then, while I was writing that very article, a second yes arrived. Canada Life. Who were happy to write our exact case, parent 75, child 45. The rest of the market is, at the time of writing, a big no. That said, they are reviewing.

So, the real numbers, from actual quotations from Canada Life and Just, for a nominees' annuity. Mr Miggins, 75. His daughter Amy, 45. Based on Mr Miggins using his £500,000 pension fund. The nominees' annuity, from a real quotation: £29,153.64 a year, or £2,429.47 a month. From a pension fund of £500,000.

Two providers, the same £500,000, the same two lives, the same week, the same type of annuity for both: level, no guarantee, no value protection, monthly in arrears, 100% continuation to the nominee, Amy, for the rest of her life. Both on standard, non-impaired rates, deliberately. If Dad dies, the annuity of £2,429.47 a month continues to Amy for the rest of her life.

Nominees' annuities are unequivocally excluded from your estate at death when bought together with your own annuity. That's the black letter law.

6:06What's the catch?

So, what's the catch? It can only be set up by the member themselves, and only while the member is alive, because the black letter law above, as written: it is purchased together with a lifetime annuity payable to the member. So the two annuities are purchased together, as one joint life annuity. That's important to remember. The nominees' annuity option dies with the member. Why important?

If a widow inherits a pension from her husband. Let's say Mr Miggins left that £500,000 to his wife and died, and the £500,000 passed to his widow. She would not be able to buy a nominees' annuity with it, because she was not the member. Her deceased husband was the member, and the nominees' annuity option dies with him.

The joint life nominees' annuity is secured with no guarantees and no value protection, because both of those benefits are included in the IHT calculation.

7:20Is buying one a gift?

The big unanswered question right now. Is buying a nominees' annuity a lifetime gift? Why it matters. Nominees' annuities are unequivocally excluded from your estate at death when bought together with your own annuity. Fact. However, the purchase of a nominees' annuity may not be exempt as a lifetime gift. If that is true, then the purchase of a nominees' annuity may possibly be a potentially exempt transfer, a PET.

Can you see now why I opened my LinkedIn article with: Just when you thought it was safe...

8:03Bill's example: how a PET could arise

Here is the logic behind the argument. Follow Mr Miggins' brother, Bill. His pot is £100,000. The single life annuity he can buy is £10,000 a year. He chooses to give some of that to his son. He buys a 100% continuation nominees' annuity, and his own income drops to £5,000 a year. So he has given away half of his pension to his son.

Apply that same proportion to his pot, half of £100,000, and that's a gift of £50,000. Those are round numbers to show the idea. Although I am sure the HMRC actuaries would not make it that simple. That's what could make the nominees' annuity a PET, in plain words. Bill gives his son half his pension, £50,000, on the day he buys the annuity.

If he lives another seven years, the taxman never looks at it again. Happy days. If he dies at any time before that seventh anniversary, the taxman potentially could count the £50,000 against his estate as a failed PET, and charge 40% IHT: £20,000 tax. That's my understanding of how the PET could be calculated, but again, happy to be corrected. My thoughts.

On my reading of the black letter law as it is, buy one before 6 April 2027, and it may be a PET. Buy one after 6 April 2027 out of a pension trust, and it may no longer be a gift at all. Bit of a bugger's muddle, isn't it?

This is a very complex subject, far too complex for this video, but I have written about it extensively in my LinkedIn article, Osborne's Get Out of Jail Card Under Attack, which you can see on screen and in the description below.

10:22The hedge

The hedge. Even if buying the nominees' annuity is a gift, the risk is dying inside those seven years. One way to cover that risk is a whole of life plan. It pays out exactly when the gift fails, so it is the hedge. I can hear the sharp intake of breath by millions of boomers across the country. Not life insurance. Please listen to the words of a Chartered Insurance Risk Manager.

Term insurance insures against something that might happen. That's life insurance, with a letter I, and is no different to insuring your car. And in that respect a cost to you and your family. Whole of life assurance is different. It is assurance, with an A. Life assurance. You assure against something that will happen. I.e. death.

Those premiums paid into a whole of life plan, and potentially a lot more money added on top, will be paid, and more potentially into trust, provided the plan is set up properly, and premiums are paid. The unknown is. When. When will that payment be made. It is assured, certain to happen, the only unknown is when.

11:51When both lives end early

Which leaves one more risk. The risk here is both lives ending early. If Dad dies early, the whole of life pays out, and the annuity continues to Amy. But if Amy were then to die early as well, the continuation dies with her. Bad. Mr Miggins and Amy both having a premature death does sadly happen. Look at the fairly recent family helicopter crash on holiday: mother, father, two kids, killed in one disaster.

So it's not just Amy dying first, it's both of them dying together. It's a dark subject, I know, but it is a reality. So Amy takes out a ten year term policy on her own life. In trust. Amy is 45 and in good health, and the risk is managed. But you need your health. And time is the one asset nobody can buy.

12:52The answer in brief

So, what is a nominees' annuity? A joint life annuity where the second life is a child or grandchild, or anyone else that you, the member, nominate. How does it work? Mr Miggins, 75. His daughter Amy, 45. At a 5.83% annuity rate. On a fund of half a million pounds. That buys a joint life annuity for Dad of £29,153.64 a year.

And when Dad dies, the annuity continues to Amy for the rest of her life. Nominees' annuities are unequivocally excluded from your estate at death when bought together with your own annuity. Fact. The income to Amy is taxable, yes, but she can potentially get most, if not all, or even more back through salary sacrifice, by putting that income she received from Dad's pension back into her own pension. What's the catch?

It can only be set up by the member, and only while the member is alive. Everything is done with no guarantees and no value protection. The purchase of one may not be exempt as a lifetime gift. And the risk here is both lives ending early. And if Amy puts her income back into her own pension, then Dad is funding her pension with his, from beyond the grave.

And if he hedges with whole of life, potentially a big payout to Amy as well, in trust. While reducing his taxable estate for IHT.

14:39Next video, and Roy Jenkins

Whole of life assurance will be the subject of my next video. And I'll leave you with the famous words from Roy Jenkins, as true now as it was when he said them in March 1986, when talking about inheritance tax: a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue. Thank you.