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Risking an annuity?

Including Financial Independence and Retiring Early (FIRE)
kempiejon
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Re: Risking an annuity?

#611672

Postby kempiejon » August 28th, 2023, 12:18 pm

frugal90 wrote:She'll have her annual allowance then pay tax on the extra. Because the annuity has only started, very little tax this year.


Ah but isn't there more to it than that? Is this a purchased life annuity? As TJH said up thread I too think part of some types of annuity payment can be a return of capital and so you don’t pay income tax on the capital. L&G have this to say
A purchased life annuity is an annuity that you buy with money that doesn’t come from a pension pot. So you could invest money from a house sale, your savings or an inheritance in one. Any income from it is untaxed. That’s because the government assumes that you’ve already paid tax on the money you spend on it.

https://www.legalandgeneral.com/retirem ... f-annuity/

mc2fool
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Re: Risking an annuity?

#611676

Postby mc2fool » August 28th, 2023, 12:35 pm

kempiejon wrote:
frugal90 wrote:She'll have her annual allowance then pay tax on the extra. Because the annuity has only started, very little tax this year.

Ah but isn't there more to it than that? Is this a purchased life annuity? As TJH said up thread I too think part of some types of annuity payment can be a return of capital and so you don’t pay income tax on the capital. L&G have this to say
A purchased life annuity is an annuity that you buy with money that doesn’t come from a pension pot. So you could invest money from a house sale, your savings or an inheritance in one. Any income from it is untaxed. That’s because the government assumes that you’ve already paid tax on the money you spend on it.

https://www.legalandgeneral.com/retirem ... f-annuity/

Hmmm ... and yet this What are Purchased Life Annuities and how are they taxed? page from the Pru says:

Tax is only payable by individuals on the interest content of the annuity. (my underline). And:

PLA taxation uses the terms; 'capital element', an 'exempt sum', or an 'exempt proportion', depending on the circumstances.
The deemed capital element/exempt sum/exempt proportion is free of UK income tax as this is simply a return of the purchaser’s capital.
The remaining portion of each annuity payment is deemed to be taxable savings income.
(my underline)

So if it's savings income it presumably (?) is not only eligible for the personal allowance and savings allowance but also for the starting rate for savings ... (That page doesn't mention those.)

mc2fool
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Re: Risking an annuity?

#611682

Postby mc2fool » August 28th, 2023, 12:50 pm

mc2fool wrote:So that's £93,750 paid now and £21,400 (£107K/5) paid out to her over the next year and in each of the following four years? Paid monthly?

Ok, well with no answers on that to allow anyone to figure the rate of return for the purpose of making any comparisons, FWIW ....

Assuming £93,750 was paid in on the 1st of the month and £107,000/60 = £1783.33 was paid out on the 1st of each and every one of the following 60 months, then XIRR gives an annualised rate of return of 5.46%.

genou
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Re: Risking an annuity?

#611687

Postby genou » August 28th, 2023, 12:58 pm

The calculation for what is capital and what is interest is here : https://www.gov.uk/hmrc-internal-manual ... l/iptm4320 ( as an annuity certain, rather than a life annuity, the value is easier to calculate, however. But in either case the insurance company will crunch the numbers.)


The interest is taxed as such, so should fall within the savings income allowances.

Howard
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Re: Risking an annuity?

#611690

Postby Howard » August 28th, 2023, 1:07 pm

The interesting feature of this thread is that the term “annuity” can have a lot of meanings. A bit like the term “bond”.

Reading the above comments, I have learnt several things about annuities that I didn’t know before!

The tax implications of any annuity are obviously critical. I considered a retirement style annuity around 20 years ago when returns were high. Looking back I’m pleased that I went for a SIPP and ISAs. As a higher rate taxpayer the net annuity returns would not have been that good compared with my investment returns (approx 8% pa) which have been virtually tax free, given that a only a modest drawdown has been taken from the SIPP in addition to the 25% tax free allowance and income from ISAs. On the capital front the bulk of the ISAs are still there. The SIPP has grown to a substantial amount and can be passed to children and grandchildren free of IHT (assuming current legislation applies).

A short term annuity does look simple but I’d be surprised, given the fees incurred in setting it up and running it, if it beat the returns of a diy investment. Obviously from a risk viewpoint one can’t predict five year returns but the diy approach worked for me (so far ;) ).

regards

Howard

PS Thanks for the estimate of the annual return mc2fool. We don't know if there might be some initial fees to take off as well?

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Re: Risking an annuity?

#611697

Postby mc2fool » August 28th, 2023, 1:38 pm

genou wrote:The calculation for what is capital and what is interest is here : https://www.gov.uk/hmrc-internal-manual ... l/iptm4320 ( as an annuity certain, rather than a life annuity, the value is easier to calculate, however. But in either case the insurance company will crunch the numbers.)

The interest is taxed as such, so should fall within the savings income allowances.

The afore linked to page from the Pru has more or less a direct copy'n'paste from that HMRC manual page, but it's not clear that that's what applies to the OP's case as it says:

"This formula applies where both the term and the amount of the annuity payments are solely dependent on the duration of human life."

But that's not the case for the OP as they've bought a 5 year fixed term annuity.

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Re: Risking an annuity?

#611698

Postby mc2fool » August 28th, 2023, 1:39 pm

Howard wrote:PS Thanks for the estimate of the annual return mc2fool. We don't know if there might be some initial fees to take off as well?

Correct, we don't know. ;)

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Re: Risking an annuity?

#611700

Postby genou » August 28th, 2023, 1:44 pm

mc2fool wrote:
"This formula applies where both the term and the amount of the annuity payments are solely dependent on the duration of human life."

But that's not the case for the OP as they've bought a 5 year fixed term annuity.


https://www.gov.uk/hmrc-internal-manual ... l/iptm4200

Annuities certain are not annuities in the true sense at all. The tax treatment of the payments is thus similar to that of purchased life annuities, but they are not within the scheme described at IPTM4300 as the dissection arises on first principles. If written by an insurance company they are in fact a variety of capital redemption policy, see IPTM1120, and consequently are potentially within the chargeable events regime, see IPTM3300, though they are not likely to give rise to chargeable events, see IPTM3400.

A UK-resident insurance company will deduct tax at the basic rate from the payments it makes, but from the interest parts only. In total, the interest parts will be equal to the amount by which the sum of the annuity payments exceeds the purchase price of the annuity


But the calc to arrive at capital/interest is the same - the one I pointed at initially.

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Re: Risking an annuity?

#611718

Postby mc2fool » August 28th, 2023, 2:44 pm

genou wrote:
mc2fool wrote:
"This formula applies where both the term and the amount of the annuity payments are solely dependent on the duration of human life."

But that's not the case for the OP as they've bought a 5 year fixed term annuity.

https://www.gov.uk/hmrc-internal-manual ... l/iptm4200

Annuities certain are not annuities in the true sense at all. The tax treatment of the payments is thus similar to that of purchased life annuities, but they are not within the scheme described at IPTM4300 as the dissection arises on first principles. If written by an insurance company they are in fact a variety of capital redemption policy, see IPTM1120, and consequently are potentially within the chargeable events regime, see IPTM3300, though they are not likely to give rise to chargeable events, see IPTM3400.

A UK-resident insurance company will deduct tax at the basic rate from the payments it makes, but from the interest parts only. In total, the interest parts will be equal to the amount by which the sum of the annuity payments exceeds the purchase price of the annuity


But the calc to arrive at capital/interest is the same - the one I pointed at initially.

Ok, well it still requires the actuarial value then, so, wanna give us a worked example? ;) The OP doesn't say how old his wife is but let's say 60, and we know the annuity payment and purchase price, so ....... :D

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Re: Risking an annuity?

#611731

Postby frugal90 » August 28th, 2023, 3:22 pm

Wife just turned 55.

We put money in a SIPP to cover the gap between retiring and taking teachers pension in full, without actuarial reduction at age 60.

The pot was £125k, she got 25% tax free, the rest has bought a five year fixed term annuity.

We looked at short term money market and managing the drawdown ourselves, but the numbers for the annuity worked for us.

We went direct with Canada life, no broker involved.

Between us we have plenty of emergency cash, quite reasonable ISA holdings in mostly ITs, so we wanted certainty with this.

We are happy with the result and as mentioned, the idea was actually run down the £125k to zero over 5 years, however, I don't think we'll need to, so will invest the tax free lump sum to bring in an extra £1.5k per annum but not probably in year 1 or 2 as we don't need it.

If interest rates hadn't risen we would have had a very different approach.

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Re: Risking an annuity?

#611734

Postby frugal90 » August 28th, 2023, 3:25 pm

"Assuming £93,750 was paid in on the 1st of the month and £107,000/60 = £1783.33 was paid out on the 1st of each and every one of the following 60 months, then XIRR gives an annualised rate of return of 5.46%."

Pretty much what we worked out and figures corrolate!

mc2fool
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Re: Risking an annuity?

#611735

Postby mc2fool » August 28th, 2023, 3:35 pm

frugal90 wrote:We put money in a SIPP to cover the gap between retiring and taking teachers pension in full, without actuarial reduction at age 60.

The pot was £125k, she got 25% tax free, the rest has bought a five year fixed term annuity.

Ah, well, in that case, IIUC, it's not a purchased life annuity but a pensions annuity, and if so then the income received will be taxed at the normal income tax rate of 20%, after the personal allowance.

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Re: Risking an annuity?

#611736

Postby frugal90 » August 28th, 2023, 3:48 pm

Indeed that is the case

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Re: Risking an annuity?

#611747

Postby genou » August 28th, 2023, 4:53 pm

mc2fool wrote:Ok, well it still requires the actuarial value then, so, wanna give us a worked example? ;) The OP doesn't say how old his wife is but let's say 60, and we know the annuity payment and purchase price, so ....... :D



I must read more slowly. The calc is in fact different.
The tax treatment of the payments is thus similar to that of purchased life annuities, but they are not within the scheme described at IPTM4300 as the dissection arises on first principles. ( Emphasis added ) So now we need to know what those first principles are:

Perrin v Dickson (1929), 14TC608. The reasoning is that, as the term is known from the start, it is straightforward and correct to determine the amount of exempt capital comprised within each payment.

So my bet is that you end up with (107-93.5)/60 = ~221 of each monthly payment is taxable as interest, if they stick with not using time value of money in the calc, which is the way of IPTM4300 . But I can't find a non-subscription way to see PvD, so that's not the final word.

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Re: Risking an annuity?

#611768

Postby Dod101 » August 28th, 2023, 7:04 pm

Sounds as if the OP does not really understand your question mc2fool. It seems difficult to get the story from the web because most annuities are bought from pension assets. The taxable income from purchased life annuities are I think subject to PAYE and the 'interest' element is thus regarded as taxable income not interest. That is in accord with what I have always understood anyway and I think is the answer.

Dod

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Re: Risking an annuity?

#611780

Postby Alaric » August 28th, 2023, 8:15 pm

Dod101 wrote: It seems difficult to get the story from the web because most annuities are bought from pension assets


Taxation of PLA's is a topic in its own right, but not relevant to this discussion as the OP tells us that the five year annuity was financed from the proceeds of a SIPP. Thus it's inside the PAYE regime.


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