A purchased life annuity deal refers to an annuity plan that is purchased with funds other than the pension funds of an individual. The money used for this purchase can be funds saved in other investment vehicles like an ISA. It could equally be funds from the savings account of an individual and it can also be the tax free lump sum withdrawn from a pension pot. As soon as tax-free lump sum has been withdrawn, an individual can do whatever they want with the capital.
As soon as the contract has come into play, the terms and conditions of a Purchased Life Annuity contract cannot be altered just as it is with other annuity contracts. Therefore the income agreed stays the same along with any additional options you may have included in the contract. The income you will receive from most annuity providers is determined by certain factors. The first is your age as the rates hinge heavily on your assumed life expectancy. Your state of health and size of your premium amount also affects it a great deal too. If you decide to include any additional benefits to the annuity deal, your monthly income will be adjusted to accommodate any benefits you may have included into the deal.
Since the options you chose and income payable from the annuity are fixed once you have bought the annuity, it is very important for you to explore and understand all the options available before you try to purchase the plan.
Taxation on purchased life annuities
With purchased life annuities, the taxation is favourable and it is in fact one of the main reasons why many people choose to go with it. This is how taxation works with purchased life annuities. Since the annuity is purchased using funds from an individual’s savings, the HMRC considers part of the income paid to the annuitant each month as a return on capital and this part is therefore considered to be tax-free. The only part of the income that is taxed by the HMRC is the one they consider to be interest on capital meaning that less tax is paid on the total income payment.
Generally, the example you will be provided with when applying for purchased life annuities will show you the gross income payable to you as well as how much tax will be reduced for every particular case.
What are the main options you can add to your purchased life annuity deal?
The main options you can add in your purchased life annuity contract include the following:
A spouse or dependants pension: Income will continue to be paid to your spouse or partner even when you have passed on. You have the option of allowing 100%, 67% or 50% of the income to go to your spouse when you pass on. The higher the percentage you choose, the costlier the contract. This doesn’t mean you will be required to come up with more money but rather your monthly income will be much lower than what it should have been.
Guaranteed period: With a guaranteed period, you are ensuring that your income will continue to be paid even if you die within a certain time limit. Generally, the guaranteed period you can choose is 5-10 years maximum. Guaranteed periods are not expensive and they offer the individual additional security for your annuity income.
Escalation: Inflation is one of the biggest concerns of annuitants especially individuals who took out annuity plans very early. This is because no one wants the purchasing power of their retirement income to be eroded by inflation. In other to fight this, providers make it possible for individuals to choose their income to increase by a fixed percentage each year. The highest percentage allowed by many providers is 8%. Alternatively, you can decide to have your annuity income linked to the RPI. Adding the option for escalation is very expensive as it is likely to reduce the initial amount you will be receiving as income during the early periods of the contract. However, it is still very important for you to include this option in your purchased life annuity deal as a young retiree.
Protection of capital: With this option the amount you paid into the annuity plan will be refunded to a named beneficiary minus any amount of money that has already been paid out to you. This is applicable to any age there are no tax deductions since it is considered a return of your capital.