Purchased Life Annuity UK
The following tables show the best 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 60 to 85. A comparison has been made for a single life, level annuity on a single life and joint life with 50% dependents income basis. No enhanced annuity rates are included, where the annuitant suffers from ill health, is a smoker or is overweight.
Last reviewed: 23rd February 2012
Level Annuity, Single Life
The above table can be compared to the retirement income from pension annuities or see annuity rates. 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 purchased life annuities 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.
Tax free capital per £1,000 income
The above table shows that the older the annuitant is when acquiring
a purchased life annuity, the higher the capital element and as a result, the lower the tax liability on the income. For example, a male basic rate taxpayer aged 70 will pay tax on £148 per £1,000 of income compared to a 60 year old that will pay tax on £287 per £1,000.
Under section 656 of the Income and Corporation Taxes Act 1988 (ICTA) part of the income from purchase life annuities is regarded as a return of capital that is free of tax but the interest element will be taxable. This means the tax treatment of a purchased life annuity is very favourable when compared to other types of investments including pension annuities. The tax paid depends on the proportion of capital and income paid to the annuitant and insurance companies have agreed these proportions with the HM Revenue & Customs (HMRC).
For example, a male basic rate taxpayer aged 65 buys a purchased life annuity with £100,000 as a level annuity, no guarantee, without proportion and paid monthly in arrears. The income he receives is £6,456 pa gross of which £4,980 pa is capital and paid tax free.
From the balance of £1,476 pa the insurance company must deduct 20% from the income element or £295 pa and pay this to HM Revenue & Customs. This means the annuitant is left with £6,160 pa, with no further tax to pay resulting in an effective tax rate of 4.5%. This compares very favourably with the 20% basic tax rate payable on a pension 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 3.0% gross or 2.4% net of basic rate tax of 20% rate tax for the tax year 2011/12. 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.
Comparison of income from £100,000
Assuming the annuitant does not require the capital, then a purchased life annuity for the male aged 65 provides an income after tax of £5,656 pa which is £3,256 pa 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 of £5,320 pa which is £2,920 pa greater than a bank or building society.
At retirement the individual can use a pension fund to buy an annuity and has the option to use an open market option to search for the highest pension annuity, taking a tax free lump sum that can also be used to buy a purchased life annuity. Once you have purchased an annuity it cannot be changed, so learn more aboutannuities, compare annuity rates and before making a decision at retirement, secure a personalised pension annuities quote offering guaranteed rates.
Inheritance tax planning
The individual could use purchased life annuities to reduce a future inheritance tax (IHT) liability. In buying a purchased life annuity any amounts in excess of the nil rate band, £325,000 for the tax year 2009/10, 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 £650,000, 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 £106,000. In the 'will', they leave their assets to their spouse and then to their children. The estate on second death is worth £606,000 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 £696,000. 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 2009/10). 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.