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The Role of Purchased Life Annuities in Retirement and Tax Planning

Many people know what a conventional annuity is: a guaranteed income for life or for a set term, purchased from pension monies.

The purchased life annuity, however, is a lesser known sibling of the conventional annuity and has some unique features that could be incorporated as part of your retirement planning.

A purchased life annuity is similar to a conventional pension annuity in the following respects:

  • A single premium is used to set up the policy through an insurance company
  • It provides a guaranteed regular income for life or for a set term
  • You can select for the income to be level, increase in line with a set rate or with inflation
  • You can add a spouse’s income and/or a guarantee period

The following factors set the purchased life annuity apart from the conventional annuity and could provide some useful tax planning opportunities.

The Potential Benefits of a Purchased Life Annuity

 1. The premium can come from your savings, pension tax free cash, or investment sale proceeds. This can be useful where you have a significant cash sum but little monies held within a pension. This is also useful from an Income Tax and Inheritance Tax Perspective, as explored below.

2. You do not have to wait until age 55 to set one up. Because non-pension money is used to purchase this type of annuity you do not have to wait until age 55 (the earliest age you can generally access your pension monies) to purchase it. This is particularly useful for those considering retirement before age 55 but who would still like an element of secure income, perhaps until their State Pension comes into payment.

3. The income received comprises of a tax-free capital element and savings income element.

    • In most cases, HMRC allows the annuity provider to treat part of each income payment as a return of the original premium, meaning no tax is due on this element.
    • You can use your available Personal Savings Allowance against the savings income element of the annuity income

The Personal Savings Allowance is currently £1,000 per annum for basic rate taxpayers and £500 per annum for higher rate taxpayers. Based on your individual situation, this could mean that the full income received from your purchased life annuity is tax free. There is no Personal Savings Allowance for additional rate taxpayers.

4. Monies used to purchase the annuity are immediately outside of your estate for Inheritance Tax Purposes. Because an entitlement to future income does not hold a value for inheritance tax purposes, the monies used to purchase the annuity are immediately outside of your estate for inheritance tax, with no requirement to survive a certain number of years thereafter for it to be effective. It is important to remember, however, that any income received from the annuity which has not been spent at the time of your death will fall within your estate.

Due to recent interest rate increases, annuity rates have increased significantly compared to previous years and this has resulted in annuities once again becoming an attractive contender in retirement income planning.


If you would like to understand whether a purchased life annuity may be suitable for you, please contact us on 0330 320 9280, email or complete our online enquiry form for advice relating to your own personal circumstances.


The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice.


You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.


Craven Street Financial Planning Limited is authorised and regulated by the Financial Conduct Authority.

Bethany Turton
Chartered Financial Planner
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