Shares + annuity

[Myfyr]

Yes, I get the legality of the ownership and that they expect to make a profit. But surely, on average, they must pay back more than the amount paid in or else why would the purchaser bother? The annuity provider must expect an investment return of X% but only pay out X-Y% where Y% is their fee for giving the purchaser certainty.

Hence my question: is an annuity a good addition to a portfolio for reducing risk? How does one decide? I'm interested to know if anyone is taking this path.

TJH has pretty well covered it. People buy annuities for the security of the payment, month by month year by year until they die. Then the annuity contract dies with them. A bit like Defined Benefit pensions, people are inclined to under value them. They remove the investment risk both in terms of the investment return, the risk of running out of money and the general hassle of managing cash flows. If you think of an annuity as a sort of Defined Benefit pension it then makes more sense. The difference is that only part of it is taxed so I guess you will have a lower tax charge for an annuity then for the same DB pension. An annuity payment is regarded by HMRC as partly a return of your capital (untaxed) and partly the investment return (taxed) whereas of course the entire payment is taxed in the case of a DB pension.

For many people buying an annuity to sit alongside an investment portfolio may make sense as it will reduce the investment risk and as I have said, provide a risk free income.

Dod

This is incorrect. If you use your pension fund to purchase an annuity, 100% of it is classed as taxable income and is taxed in the same way as if it was a salary (but not subject to NI).

You are describing a purchased life annuity which you buy from your own funds (eg a savings account, not a pension) which are a totally different animal. Part of the income of these is treated as a tax free return of your original capital (the older you are when you buy it, the greater the proportion as it is spread over your expected lifetime) and the rest of your payment is taxed as income.

Purchased life annuity rates are generally poorer than pension annuity rates because of mortality selection (you would be unlikely to buy a purchased life annuity if not in excellent health, certainly less likely than a pension annuity). They are also usually a life policy not a pension one so that can impact (reduce due to tax) the investment return used by the insurer when pricing the product making the rates lower.

Also you never received tax relief on the money used to buy a PLA, hence the ongoing tax free capital return proportion!

[Dod101]

This is incorrect. If you use your pension fund to purchase an annuity, 100% of it is classed as taxable income and is taxed in the same way as if it was a salary (but not subject to NI).

You are describing a purchased life annuity which you buy from your own funds (eg a savings account, not a pension) which are a totally different animal. Part of the income of these is treated as a tax free return of your original capital (the older you are when you buy it, the greater the proportion as it is spread over your expected lifetime) and the rest of your payment is taxed as income.

Purchased life annuity rates are generally poorer than pension annuity rates because of mortality selection (you would be unlikely to buy a purchased life annuity if not in excellent health, certainly less likely than a pension annuity). They are also usually a life policy not a pension one so that can impact (reduce due to tax) the investment return used by the insurer when pricing the product making the rates lower.

Also you never received tax relief on the money used to buy a PLA, hence the ongoing tax free capital return proportion!

I don't think it is incorrect but we are talking about two different types of annuity. No one has so far defined which one they are talking about and I was certainly writing about what I would call a 'true' annuity, not a conversion of say the lump sum in a SIPP, or other pension funds for instance into an annuity. Were I to be buying an annuity I would be taking my own funds and indeed have done so to buy the short term annuity I mentioned. There it is a standalone contract and HMRC recognises part of the annuity as a return of my capital and thus is untaxed. Using designated pension funds, of course you have already received tax relief on the contributions.

I am not sure that your explanation of poorer annuity rates for purchased life annuities stand scrutiny because if you are in poor health (have impaired life expectancy) you will get a much better return than someone in excellent health, at least that is the way they used to work, in recognition of the shorter life expectancy.

Dod

[Myfyr]

This is incorrect. If you use your pension fund to purchase an annuity, 100% of it is classed as taxable income and is taxed in the same way as if it was a salary (but not subject to NI).

You are describing a purchased life annuity which you buy from your own funds (eg a savings account, not a pension) which are a totally different animal. Part of the income of these is treated as a tax free return of your original capital (the older you are when you buy it, the greater the proportion as it is spread over your expected lifetime) and the rest of your payment is taxed as income.

Purchased life annuity rates are generally poorer than pension annuity rates because of mortality selection (you would be unlikely to buy a purchased life annuity if not in excellent health, certainly less likely than a pension annuity). They are also usually a life policy not a pension one so that can impact (reduce due to tax) the investment return used by the insurer when pricing the product making the rates lower.

Also you never received tax relief on the money used to buy a PLA, hence the ongoing tax free capital return proportion!

I don't think it is incorrect but we are talking about two different types of annuity. No one has so far defined which one they are talking about and I was certainly writing about what I would call a 'true' annuity, not a conversion of say the lump sum in a SIPP, or other pension funds for instance into an annuity. Were I to be buying an annuity I would be taking my own funds and indeed have done so to buy the short term annuity I mentioned. There it is a standalone contract and HMRC recognises part of the annuity as a return of my capital and thus is untaxed. Using designated pension funds, of course you have already received tax relief on the contributions.

I am not sure that your explanation of poorer annuity rates for purchased life annuities stand scrutiny because if you are in poor health (have impaired life expectancy) you will get a much better return than someone in excellent health, at least that is the way they used to work, in recognition of the shorter life expectancy.

Dod

I was thinking about pension annuities as this is a retirement board. Purchase life annuities are very much a niche product these days with fewer providers and therefore less competition.

Both annuity types are priced to generate a contribution towards profit of course.

[Dod101]

I don't think it is incorrect but we are talking about two different types of annuity. No one has so far defined which one they are talking about and I was certainly writing about what I would call a 'true' annuity, not a conversion of say the lump sum in a SIPP, or other pension funds for instance into an annuity. Were I to be buying an annuity I would be taking my own funds and indeed have done so to buy the short term annuity I mentioned. There it is a standalone contract and HMRC recognises part of the annuity as a return of my capital and thus is untaxed. Using designated pension funds, of course you have already received tax relief on the contributions.

I am not sure that your explanation of poorer annuity rates for purchased life annuities stand scrutiny because if you are in poor health (have impaired life expectancy) you will get a much better return than someone in excellent health, at least that is the way they used to work, in recognition of the shorter life expectancy.

Dod

I was thinking about pension annuities as this is a retirement board. Purchase life annuities are very much a niche product these days with fewer providers and therefore less competition.

Both annuity types are priced to generate a contribution towards profit of course.

Interesting all told. I freely admit that I do not know too much about pension annuities but that would explain TJH's comments. We all live and learn.

Dod

[Myfyr]

I was thinking about pension annuities as this is a retirement board. Purchase life annuities are very much a niche product these days with fewer providers and therefore less competition.

Both annuity types are priced to generate a contribution towards profit of course.

Interesting all told. I freely admit that I do not know too much about pension annuities but that would explain TJH's comments. We all live and learn.

Dod

Not a problem!

[88V8]

But would shares + annuity be an alternative?

As has been said, they are fire-and-forget, if that is what one wants.
But why would one give up the capital when a 5% yield can easily be achieved from a basket of Income ITs, and one still has the capital or worst case, most of it.

Then there's inflation of course ... if we optimistically assume 3% average over ten years, a level £5,000 will become £3,720 which is not much fun.

I would really see an annuity as a last resort if I am in danger of becoming gaga.

V8.