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 annuities 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 purchased life annuities 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 annuities 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 annuities. 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;

standard single rates smoker single rates standard joint rates smoker joint rates diabetes annuity rates with profits annuity rates impaired life rates immediate needs rates

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 65 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.

Male single life Female single life   male 65 £6,870     male 70 £8,280     male 75 £9,700     male 80 £12,310     male 85 £16,060     female 65 £6,400     female 70 £7,600     female 75 £8,800     female 80 £10,210     female 85 £14,760   Level Annuity, Joint Life Male + Female spouse joint rates   male 65 and female 65 £6,470     male 70 and female 70 £7,660     male 75 and female 75 £8,860     male 80 and female 80 £11,270   The above are examples of the rates available. Click the following for the full lump sum tables and other annuity options.

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.


Tax treatment
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 £6,870 gross of which £5,716 is capital and paid tax free.

From the balance of £1,154 the insurance company must deduct 20% from the income element or £231 and pay this to HM Revenue & Customs. This means the annuitant is left with £6,639, with no further tax to pay resulting in an effective tax rate of 3.4%. 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 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, 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.

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 about annuities, 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, £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.