Interactive Investor

Can you explain how annuity payments work and how they are taxed?

25th September 2019 00:22

Helen Morrissey from interactive investor

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Q

Could you explain how annuity products work? Looking at the comparisons in the Best Buys section of the magazine each month, is the first column of figures the amount paid out each month or is the third column this figure?

Also, when buying an annuity, is tax paid on the whole sum put forward or is tax deducted from the monthly contributions instead? Roughly how much monthly income might be attainable from an annuity of £250,000?

From: JP/Kendal

A

We give you the figures for two types of annuity: conventional annuities, which are for people with no health conditions; and enhanced annuities, which can be bought by people who may have smoked or have various other health conditions – these generally give a bigger income than conventional annuities. 

Looking at the Best Buy tables below, the figure in the first column after age is the annual amount you can expect to be paid out if you bought an annuity with a 'level income' – an income that will not change over time and is not linked to a measure of inflation.

The amount in the right-hand column is the initial annual income you would get if you wanted your income to be linked to inflation, otherwise known as index linked. This means you will generally receive a lower income at the start of your retirement, but it will increase over time.

This means it should cover increases in the cost of living, including food and energy bills.

In terms of taxation, you can take 25% of your pension tax free before you buy an annuity. Tax will then be deducted from the monthly payments.

The amount of income you can get from an annuity will differ depending on the type of annuity and which provider you choose.

However, as a rough estimate, if you bought an index-linked annuity, £250,000 worth of pension savings should generate an annual income of around £9,000 a year – this equates to approximately £750 a month.

Top three example rates on £50,000 purchase price (as at 2 September 2019)

Conventional annuities (Gross annual income from £50k pot)

Age Non-inflation-linked annuity   RPI-linked annuity  
65 Legal & General £2,494.56 Legal & General £1,454.16
  Aviva £2,402.40 Aviva £1,446.96
  Scottish Widows £2,391.96 JUST £1,314.36
         
70 Legal & General £2,920.20 Legal & General £1,814.76
  Scottish Widows £2,896.56 Aviva £1,763.64
  Just £2,799.60 JUST £1,705.92
         
75 Scottish Widows £3,623.28 Legal & General £2,291.04
  Legal & General £3,434.52 Aviva £2,289.84
  Just £3,317.76 Scottish Widows £2,231.28

Source: JLT Pension Decision, Sep 2019

Enhanced annuities (gross annual income from £50k pot)

Age Non-inflation-linked annuity   RPI-linked annuity  
65 JUST £2,603.52 Aviva £1,532.88
  Legal & General £2,520.00 JUST £1,494.12
  Aviva £2,457.60 Legal & General £1,440.12
         
70 Legal & General £2,936.64 Aviva £1,901.16
  JUST £2,927.64 JUST £1,810.80
  Scottish Widows £2,896.56 Legal & General £1,793.16
         
75 Scottish Widows £3,623.28 JUST £2,385.24
  Just £3,539.88 Aviva £2,341.92
  Canada Life £3,456.48 Canada Life £2,309.04

Source: JLT Pension Decision, Sep 2019

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This article was originally published in our sister magazine Moneywise, which ceased publication in August 2020.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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