It is also possible to purchase an annuity from funds that did not originate from a pension fund. These are known as Purchased Life Annuities, and work in much the same way as an annuity from a pension, but with one notable and extremely beneficial difference.
Under pension rules the annuity you receive from a pension fund is treated as taxable income in the same way as income from normal employment would be. However if you use other monies to buy a Purchased Life Annuity, the tax treatment is different.
Some of the income received is treated as capital which is not taxed, and therefore the tax burden is reduced. The example below (based on a 65 year old male, basic rate tax payer with £100,000) illustrates the point:
- Pension Annuity – Gross Income = £7,370, Tax = £1,621, Net Income = £5,749
- Purchased Life Annuity – Gross Income = £7,370, Tax = £367, Net Income = £7,003.
The illustration assumes that both annuities have the same gross income payable.
This therefore raises the question of whether you should always exercise your option of taking tax free cash from your pension funds, even if you intend to purchase an annuity?
You should ensure that the equivalent pension annuity and purchased life annuity rates are the same, and if they are then it makes sense to withdraw your tax free cash entitlement and use a purchased life annuity, as in the above example the net benefit is over £100 per month.
Specialist can assist you in making this decision and would be happy to provide comparative illustrations.