What is an Annuity?
An annuity is an arrangement that provides a guaranteed level of income in return for a single non-returnable capital payment. You are basically buying an income. Most annuities are purchased from funds arising from pension policies and are known as Open Market Option annuities.
When a pension policy reaches its maturity date, the provider will provide confirmation of the fund value and general details of what level of annuity they can offer. What many people do not realise however, is that there is also a facility known as the Open Market Option which enables the fund value to be transferred, usually free of charge, to another annuity provider of their own choice. Annuity rates change frequently and it is essential that a policyholder uses the Open Market Option facility if they are to obtain the best rate.
With the Open Market Option annuity, the level of income will be guaranteed for the remainder of the policyholders lifetime. Annuity rates are based on life expectancy and older policyholders will therefore generally be offered higher rates than younger lives. In addition, smokers or individuals with a serious medical condition can often obtain higher rates.
Purchased Life Annuity
As well as annuities purchased through the proceeds of a pension funds, it is also possible to buy an annuity from your own capital. This can either last for the life of the annuitant or be for a term of say 10 years.
Tax
With the Open Market Option, all of the income received is liable to tax at your highest rate. If you are a non-tax payer however, the annuity can be paid gross.
With a purchased life annuity part of each payment is regarded as a return of capital and is not taxed. The balance is regarded as income or interest and is taxable.
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