WHAT IS AN ANNUITY?

An annuity is a financial arrangement in which you make a lump-sum capital investment from which you receive a guaranteed level of income.

Most annuities are bought using funds held in money purchase pension schemes. The annuity you buy is usually arranged to pay you an income for life, although it can be arranged to pay you an income for a fixed period. Various annuity options are discussed in the section headed 'Types of Annuities'.

When your pension fund reaches maturity, your pension provider will advise you of the fund value, and general information about annuities and the level of annuity income you would receive. You are then entitled to use your 'Open Market Option', which allows you to transfer the fund value to another annuity provider of your choice. This enables you to take advantage of a higher annuity income which may be available from a different provider.

You are normally entitled to take up to 25% of your pension fund as tax-free cash. The rest of the fund must be used to purchase an annuity or alternatively secured pension, called a Compulsory Purchase Annuity, before you reach 75 years of age.

TYPES OF ANNUITY

There are a wide range of options which can be selected when choosing an annuity scheme.

The most widely used annuity options are listed below.

Minimum Term the income is guaranteed to be paid until the death of the annuity holder (the annuitant), but it can also be modified to include any of the following options:-

• 5-year guarantee - annuity ceases at death of annuitant, or after 5 years, whichever is the longer

• 10-year guarantee - annuity ceases at death of annuitant, or after 10 years, whichever is the longer

• Joint life annuity - annuity ceases on the death of the second of two named annuitants

Spouse benefits - Your spouse can be protected after your death, by choosing one of the following options:-

• Reduction to half benefit,
• reduction to two thirds benefit or
• full benefit

Thus the annuity is adjusted to the new level at the death of the annuitant or at the end of the guarantee period (if selected), and continues until the death of the spouse.

Escalation - your annuity can either be paid at a fixed level or you can include an escalation at 3%, 5%, or at the % RPI (annual increase in retail price index). Thus you can choose to compensate for inflationary effects on your income. However the initial income level will be reduced if you choose escalation. 

PURCHASED LIFE ANNUITY

A purchased life annuity is an annuity purchased with your own funds, instead of from a money-purchase pension fund. It operates in the same way as a Compulsory Purchase Annuity, but it has tax advantages.

The entire pension which you receive from a Compulsory Purchase Annuity is treated as taxable income in the same way as income from normal employment would be.However when you buy a Purchased Life Annuity that part of the annuity income, which is calculated as capital repayment to you, is tax-free. Only that part of your annuity income which is interest paid on your investment is taxable.

With similar annuity rates, the effect of this tax treatment of a Purchased Life Annuity, for a basic rate tax-payer, would be to increase nett income by approximately £200 per month, from a £200,000 investment.

Your consultant can assist you in making optimum decisions for such investments, and would be happy to provide comparative illustrations of such options.

Contact Annuity Advice UK now by completing our quick and easy, confidential, NO-OBLIGATION annuity enquiry form (minimum £10,000)...