topics this page:   • who benefits • capital and interest     • annuity rates • tax treatment     • income comparison • inheritance tax planning     • added features • capital protection

Who benefits
Anyone that is typically aged 55 or over, has a large lump sum and want a guaranteed income for the rest of their life can benefit from purchased life annuities. Most providers set a minimum lump sum of £20,000 (or even higher) so often an individual will only be in this position when they retire and commute part of their pension fund to a tax free lump sum. They may also have been the beneficiaries of a will and have inherited a property that is later sold, and now they want to supplement their income.

The purchased life annuity market is not as developed as the compulsory purchase annuity (pension annuity) market so the income from the same size of lump sum is less, usually between 80% and 90% of the pension income. Also the insurance companies believe that because there is no compulsion to buy a purchased life annuity, as there is with a pension annuity, they are going to be selected against. In other words, only healthy people would buy a purchased life annuity and therefore this will reduce the mortality profit in this market and therefore reduces the rates offered.

Despite this lower income, the annuity taxation of a purchased life annuity is very favourable compared to pension annuities and it provides a higher income net of tax. This means that the majority of individuals on retirement that want to maximise their pension income should commute the maximum tax free lump sum and use this for a purchased life annuity.


Added features
A purchased life annuity can have many of the added features of pension annuities such as a guaranteed period, being paid in advance or arrears, with proportion, single or joint life annuity or level or escalating.

Usually if the purchased life annuity is escalating, this is not offered for RPI escalation but on a fixed rate escalation basis only, typically at 3%, 5% up to a maximum of 8% escalation. The annuity can have a dependents income that operates on the same basis as a survivors pension, this being an income paid to a spouse at 50%, 66% or 100% of the annuitants income.


Capital protection
This feature is unique to a purchased life annuity. Capital protection can be selected rather than a guaranteed period. A guaranteed period would continue to make payments up to 5 or 10 years after the annuity was purchased even it the annuitant dies.

Capital protection ensures that if the annuitant dies earlier than expected, the difference between the gross income received and the original capital to purchase the annuity will be paid as a lump sum to the annuitant's estate.

To provide income after the death of the annuitant, he or she can therefore choose between a dependents income, capital protection or a guaranteed period, all with different levels of protection and associated costs.


annuity rates table
These rates tables are for purchased life annuitants. For other rates try;

The following tables show the best open market option income that can be use to buy a purchased life annuity from a lump sum of £100,000. The annuity is paid gross in arrears and does not include a guaranteed period for the income shown. It assumes the annuitant purchases the annuity for the ages from 65 to 85. A comparison has been made for a single life on a level annuity basis and 3% escalation.

The above table can be compared to the income from a pension annuity. This is only important where the annuitant wants to maximse the income from a pension fund and must decide whether to commute the tax free lump sum and to invest in purchased life annuities, or use the money and take more pension income. A comparison of annuity taxation shows the best option for a basic rate taxpayer.


Capital and interest
The income paid under a purchased life annuity contains a capital and an income element. The capital element is treated as a return of the annuitant's original investment and is tax free. The income element is taxed as savings income at a 20% rate of tax for basic rate taxpayers. Higher rate taxpayers will pay a further 20% tax.

The amount of capital paid depends on the age and sex of the annuitant as well as the other benefits attached to the annuity such as a guaranteed period and if there is any proportion added. The following table shows the tax free capital paid for ages between 55 and 85, for male and female annuitants assuming the level income is paid monthly in arrears, with no guaranteed period, without proportion and a 50% dependents income as a joint life annuity.

Income comparison
Many retired people have money in bank or building society accounts that they rely in part to provide them an income. They do not want the risk of equity exposure but need a reliable income from their savings. They may also have received money or a property from an inheritance and now want the best possible return with the minimum of risk.

The following table compares the gross and net income paid from a £100,000 investment in a bank or building society account and purchased life annuity. The interest on the bank account is assumed to be 6.0% gross or 4.8% net of basic rate tax of 20% rate tax for the tax year 2008/09. The life annuity assumes a level annuity, paid monthly in arrears, without proportion, no guarantee and no dependents income for the single life options but a 50% dependents income for the joint life option.

Assuming the annuitant does not require the capital, and then a purchased life annuity for the male aged 65 provides an income after tax of £1,840 greater than from a bank or a building society, guaranteed for the life of the annuitant. For a female aged 65 the guaranteed income after tax is £1,300 greater than a bank or building society.


Inheritance tax planning
The individual could use a purchased life annuity to reduce a future inheritance tax (IHT) liability. In buying a purchased life annuity any amounts in excess of the nil rate band, £312,000 for the tax year 2008/09, removes capital from the estate. If on first death the nil rate band is not used, 100% of this can be transferred and used on the second death. Therefore in the above example the nil rate band would be doubled to £624,000, with any excess taxed at a 40% rate.

For example, a couple that are a basic rate taxpayer, aged 65 have two children, own a property worth £500,000 and have savings of £80,000. In the 'will', they leave their assets to their spouse and then to their children. The estate on second death is worth £580,000 and therefore below the doubled nil rate band with no IHT for the children to pay. However, the couple inherits a £90,000 property and this increases the value of the estate on second death to £670,000. This means there is a potential IHT liability for the children on the excess above the nil rate band of £46,000.

If the couple sell the property and invest the proceeds to a bank or building society, it is still in the estate, there is an IHT liability and could earn interest of £4,320 net of basic rate tax (assumes interest of 6.0% gross, net of £4.8% and basic rate tax of 20% for the tax year 2008/09). If they buy purchased life annuities on a joint basis, a level annuity, no guarantee, without proportion, paid monthly in arrears and 50% dependents income the income is £5,569 net of tax and there would not be an IHT liability.   Bookmark with: What are these?       resources   annuity pages   annuities   --------- select from --------- our services quotes & enquiries annuity directory your options open market option quote standard quote smoker quote diabetes quote impaired quote immediate needs quote with profits quote purchased life tax free lump sum with profits annuity smoker annuities diabetes annuities impaired annuity long term care immediate needs purchased life annuity annuity rates phased retirement income drawdown other annuity options annuity questions decision tree   --------- select from --------- advance or arrears annuity annuity quotes annuity rates annuity taxation anticipated bonus rate capital and interest capital protection complusory purchase deferred annuity enhanced annuity fixed rate escalation guaranteed period immediate needs impaired life level annuity medical conditions mortality mortality drag mortality profit open annuity open market option pension drawdown phased retirement purchased life RPI escalation single or joint life specialist advice staggered vesting survivors pension temporary annuity unit linked annuity with overlap with profits annuity with proportion   private pensions   pensions in retirement   --------- select from --------- appropriate pension buyout policy carry back relief carry forward relief FSAVC fund value insured pension money purchase pension fund pension term assurance personal pension private managed funds private pension scheme retirement annuity section 226 policy section 32 policy segmentation SIPP scheme stackholder pension   --------- select from --------- annuity annuity interest rate commutation compulsory purchase defined benefits defined contribution early retirement lump sum open market option pension drawdown pension withdrawal pension income phased retirement purchased life annuity retirement benefits staggered vesting tax free lump sum   employer pensions   pension terms   --------- select from --------- accural rate added years AVC approved scheme armed forces pension associated employers bulk transfer continuous service contracted in contracted out defined benefit scheme defined contribution dynamisation early retirement eligibility employer pension equalisation rules executive pension exempt approval final salary pension FURB scheme group pension headroom check hybrid scheme indexation limited price indexation MFR occupational pension public service scheme qualifying service reckonable service refund contributions relevant benefits revaluation salary sacriface SDC scheme SSAS temporary absence UURB scheme Winding up   --------- select from --------- concurrent membership contributions contributory scheme critical yield gross net contributions members pension rights non contributory normal pension age pension audit pension arrangement pensionable service pensions pensions review polarisation reduction in yield regular contributions retail price index retirement age scheme member state pension age tied agent