Back to basics – what is an annuity?
An annuity is a type of investment product. They are offered by insurance companies.
You transfer your pension fund(s) to an insurance company and in return they pay you an income for the rest of your life. This is known as a pension annuity. There are different types of pension annuity and lots of options you can add to this basic scenario, and we explain these on this website.
There is another type of annuity which you buy with your own money. This is known as a purchased life annuity.
You pay a lump sum (the minimum is £5,000) to an insurance company and in return they pay you an income for the rest of your life. The biggest difference between a purchased life annuity and a pension annuity is the way the income is taxed.
All of the income you receive from a pension annuity is taxable under PAYE (pay as you earn). HMRC (Her Majesty’s Revenue & Customs) will tell your insurance company how much tax to deduct from your annuity payments, so you don’t need to complete a self-assessment tax return.
However with a purchased life annuity, HMRC treat part of each income payment as a return of your original lump sum. This part is tax-free, and it is known as the capital content. The rest of your income is made up of interest, and this will be taxable at your highest rate. Again, HMRC will tell the insurance company how much tax to deduct.
The amount of income from a purchased life annuity that is tax-free is calculated by HMRC, and increases as you get older. If you are interested in purchased life annuities please ring us for a quotation.
