Purchased Life Annuities

14th October 2011

Purchased Life Annuities are annuities that are bought with money that has not come from a pension fund but rather an individual’s own savings.

This money could have been saved up in some other form of investment, like an ISA or a savings account or it could be the tax-free cash taken from a pension fund. Once tax-free cash is in an individual’s hands, it is classed as their own capital.

A purchased life annuity offers a guaranteed income for life, just like pension annuities do and it is also possible to add in spouses benefits, annual escalation and guarantee periods. In addition, it is common for individuals to consider including Value Protection, which will ensure that the residual fund (after any income has been paid out) will be left to their chosen beneficiaries in the event of their death. No tax charges apply here, as this is simply a return of the individual’s capital to their loved ones.

The taxation of Purchased Life Annuities is also considered to be favourable and is therefore well worth taking into consideration. The taxation regime works as follows:

Because the annuity is purchased with a person’s own savings, HMRC regard part of the income payable each month to be a return of capital and this part is therefore tax-free. Only that income that HMRC deems to be interest on the capital is taxable, which means that less tax is paid on the income payment. When compared to pension income, which is classed as taxable income in its entirety, this is a more favourable regime and therefore a valuable advantage.

Many people choose to use their savings in retirement to provide an additional income, which helps to supplement the income derived from their pension arrangements and they do this by investing the money in some way.

In the current market, bank and building society savings rates are extremely low, which often means that the income payable from such investments does not even keep pace with inflation. Yields from fixed interest securities are also poor at the present time and the alternative, which is to invest capital in stocks and shares is a risk that many people in retirement are not prepared to take, particularly bearing in mind the current volatility in the marketplace.

Purchased Life Annuities are an alternative to these options, as they provide a fixed and guaranteed income stream for life, albeit in return for a capital investment. Many people wish to retain access to their funds for emergency purposes in retirement and a Purchased Life Annuity will not allow this but for those who may be able to split their capital between securing additional income and retaining a sufficient ‘emergency’ fund it is well worth taking advice on this as an option before deciding on where to utilise savings to meet your requirements for the future.

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