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).Dod101 wrote: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.MrFoolish wrote: 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.
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
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!