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Purchased Life Annuity

A purchased life annuity is an annuity that is 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.

Once purchased, the terms of a Purchased Life Annuity cannot be changed, so the agreed income is guaranteed for your lifetime, as are the benefits that you choose to include within the annuity.

The income that will be paid from a Purchased Life Annuity is determined by several factors:

  • Your age
  • Your gender
  • Your state of health
  • Where you live
  • The size of your pension fund
  • Any additional benefits that you wish to include within the pension annuity

As the options chosen and the income payable from the annuity are fixed once the annuity is bought, it is essential that all of the options available are explored before you commit to buying a plan.

The taxation of Purchased Life Annuities is also considered to be favourable and is therefore 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 total income payment.

Usually, illustrations provided for Purchased Life Annuities will show the gross income payable and the net income as well, so you can easily see how much tax will be deducted in each individual case.

The main options that you can choose to add to your Purchased Life Annuity are listed below:

  • A spouses or dependants pension - Your income can continue to your spouse or partner in the event of your death. You can choose for income to continue at 50%, 67% or 100% of your income level. The greater the percentage you select, the more expensive this is likely to be.
  • A guarantee period - you can choose a minimum guarantee period of either 5 or 10 years. This means that your income will continue to be paid for the period chosen, even if you die during this time. These are relatively inexpensive to include within your arrangement and provide some additional security for your annuity income.
  • Escalation - the effects of inflation can be very damaging to income in retirement because as time goes on, the buying power of your annuity income will be eroded by the effects of inflation. To help combat this, you can choose to have an income that increases on an annual basis. You can either select a fixed annual increase i.e. 3% or 5% per year, or some providers can offer an annuity which is linked to RPI. An annual increase of any amount is a very expensive option and is likely to reduce the initial level of income offered to you significantly but this is an important point to consider, to help ensure that you help to mitigate the effects of inflation as time goes on.
  • Capital Protection - In the event of your death, the amount you invested into the annuity, less any income paid out to you will be refunded to your chosen beneficiary. This applies up to any age and no tax charge is deducted as this is a refund of you own capital investment.
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