What is a Purchased Life Annuity?

I like the idea of an annuity providing a stable income during retirement, but I never got around to saving a very big pension pot. Can I use other cash to buy an annuity or are annuities only for people with pensions?

Question asked by Ms R Simone

Annuities are most commonly used by retirees as a way of exchanging their pension pots for a retirement income. This retirement income is paid regularly and lasts until you pass away.

However, annuities aren’t just for people with pension pots. You can also buy an annuity with any lump sum of cash, perhaps from the sale of a house, an inheritance or simply regular savings you’ve built up during your life. This is known as a purchased life annuity (PLA).

Alternatively, you could buy a PLA with your pension commencement lump sum (PCLS), which is the term for the initial 25% of your pension pot you’re entitled to take tax-free at the start of your retirement.

Purchased life annuities have all the same options as an annuity, including:

Tax and Purchased Life Annuities

There are some tax advantages to buying a purchased life annuity. With a pension annuity you have received tax relief on the cash you’ve paid in throughout your working life, so the income from your pension is taxed.

With a purchased life annuity, it’s assumed you’ve paid tax on the cash you’re using to buy the annuity already (e.g. inheritance tax, income tax, capital gains tax etc.). The result is that part of your purchased life annuity isn’t taxable as income. Instead, it’s treated as a tax-free return of the initial capital invested.

A quirk in the rules means that although you can use inheritance to buy a purchased life annuity, a will can’t stipulate outright that the inheritance needs to be used to buy an annuity. If it’s written in a will that you must use your inheritance to buy an annuity, part of the annuity income won’t be treated as a return of capital.

It’s impossible to say what the best course of action is for your retirement without speaking to you and offering financial advice and reviewing your pension savings. To speak to an expert, call Drewberry today on 02084327333.

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