How to reclaim the tax on purchased life annuity income

A purchased life annuity is one where you buy an annuity from your own funds. The reason these purchased life annuity are so popular is because they are tax efficient.

As with all taxes they have to be claimed, they are not given automatically. If you do not claim them you do not get them and that would eliminate the tax effecient status of them.

With purchased life annuities the capital element is treated as a return of your original investment and is tax free. The income element is taxed as savings income at a 20% rate of tax for basic rate taxpayers. Higher rate taxpayers will have to pay a further 20% tax.

The amount of capital element depends on your age and sex as well as the other benefits attached to the annuity. For example a 65 year old male would get £832 of every £1000 as return of capital, where an 85 year old male would get £971. Both assuming the level income is paid monthly in arrears, with no guaranteed period, without proportion and a 50% dependents income as a joint life annuity.

Tax on purchased life annuities

If you’ve got a purchased life annuity, 20 per cent tax will be automatically deducted from the income element you receive from it by the annuity provider. However if your overall level of income means you’re not a taxpayer you can ask to receive purchased life annuity income tax-free. Use form R89 to do this.

Purchased Life Annuity Rates

What is a purchase life annuity?

It’s a contract that gives you an income for the rest of your life or for a select period of years, bought with a lump sum single payment.

Want to invest some money to get a guaranteed income?

Tips on purchase life annuity purchase

Why would I buy one?

This type of annuity is useful if you need a regular income and have some money to invest. You might want to:

  • top-up existing pension income;
  • pay for fees such as those for a retirement home;
  • get additional income until you receive your pension;
  • get a regular income until other investments mature;
  • provide income for a child or grandchild at college or university.

If you’ve a lump-sum to invest from a source such as:

  • a sale of a house or shares;
  • a tax-free lump sum from a pension fund;
  • your savings;
  • an inheritance;
  • an unexpected windfall;
  • a maturing life plan; or
  • a redundancy payment,

What about tax?

Part of the income you receive is tax-free. Your gross income payments are made up of two parts, a ‘capital’ part and an ‘interest’ part. The capital part is treated as a return of your capital and so is not taxed. We normally pay the interest part after deducting tax at the savings rate. You may need to pay more or less than this, depending on your tax rate.

Open Market Option

The annuity market is very competitive and rates differ between annuity providers. You can substantially increase your pension income by purchasing your annuity from the company which pays the most income. This is called “exercising the Open Market Option.” It costs nothing to take advantage of this option and new rules introduced recently by the FSA mean that insurance companies must tell you about this option.