Buying a purchased life annuity benefits from attractive tax breaks producing up to 20% more income net of tax than a pension annuity, especially for older taxpayers.

Income from a purchased life annuity (PLA) benefits from attractive tax breaks as the majority of income is deemed a return of capital by HMRC.

Currently for a person with a fund of £100,000 buying an annuity on a single life, no guaranteed period and level basis aged 60 to 90 all the income is deemed as a return of capital and the income is tax free.

In contrast, if you are retired with a combination of Sate and employer pension you are likely to be a basic rate taxpayer. If you are retired and have not taken all your money purchase pensions or have pensions in drawdown, any income you take is subject to your marginal rate of tax, such as 20% basic rate tax.

Rather than using a pension to provide income, you could consider a PLA using cash from your savings where the income is 100% return of capital and paid tax free. This can result in a 14% to 20% increase in your disposable income if you are aged 75 and over.

The table above shows the net income for a basic rate taxpayer from pension and cash annuities for different ages. This is based on a fund of £100,000 buying an annuity on a single life, no guaranteed period and level basis.

Income from a purchased life annuity is particularly advantageous for people aged 75 where the income is 18% or £1,080 per year higher than a pension annuity, for an 80 year old the income is 20% or £1,510 per year higher and for an 85 year old this is 14% or £1,530 per year more income.

For younger ages there is still a benefit with a 70 year old basic rate taxpayer receiving 12% or £590 per year more income from a PLA compared to a pension annuity after tax and 9% or £330 per year higher if you are aged 60.

Increasing lifetime income

The purchased life annuity benefits from generous tax advantages as HMRC deem the majority of the income as a return of capital and therefore tax free.

For a 20% basic rate taxpayer aged 75 with a fund of £100,000 a pension annuity provides a gross income of £7,275 per year and after tax this could reduce to £5,820 per year.

If you use savings of £100,000 for a PLA the income would be £6,900 per year tax free generating an extra £1,080 per year.

In terms of total income during your life, the Office of National Statistics (ONS) would expect a male aged 75 to live for 11.4 years and he will have £12,312 more income over his lifetime. For a female she can expected to live for 13.09 years increasing her lifetime income by £14,137.

If you have uncrystallised pensions you can take the tax free lump sum and use this to buy a purchased life annuity and leave the balance in flexi-access drawdown.

For example, a 75 year old basic rate taxpayer with a pension fund of £200,000 can take the tax free lump sum of £50,000 to buy a purchased life annuity the income would be £3,450 per year tax free.

For older wealthier people with an estate greater than £1 million and beneficiaries liable to inheritance tax, buying a purchased life annuity using cash will reduce the value of the estate immediately.

This would reduce the potential IHT liability of the estate and provide a tax free income from the PLA. Any pension or drawdown plans would remain outside of your estate offering you flexible income to take in the future if needed and on death the option to nominate beneficiaries for these schemes.