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        Updated: April 16, 2024

        Are Pension Annuities Taxable?

        Learn how annuities are taxed and how to avoid paying over the odds for yours in this guide

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        For anyone who has saved into a personal pension at some stage during their working life, buying an annuity is one of the options available with the funds in order to provide an income in retirement. But, exactly how is an annuity taxed?

        If you’re thinking of buying an annuity but would like to know more about what types of taxation may be liable, give us a call on 0808 189 0463 or make an enquiry and we will arrange for a pensions advisor to get in touch.

        Are all annuity payments tax-free?

        No they’re not. With all defined contribution schemes, you are allowed to take the first 25% of the overall pension fund value as a tax-free lump sum. This is the only payment you can take which is guaranteed to be free of any income or capital gains tax.

        The remaining fund can then be used to purchase an annuity, providing you with either an income for the rest of your life or for a fixed-term, depending on the type of annuity you choose to buy.

        So, for example if you have a pension fund worth £100,000 you can take £25,000 as a tax-free lump sum. The remaining £75,000 can be used to either buy an annuity or a pension drawdown plan.

        Whichever you choose, the income you receive will not be tax exempt.

        All income received from an annuity is classed as ‘earned income’ and is, therefore, subject to income tax in exactly the same way as employment earnings using HMRC’s pay-as-you-earn (PAYE) system.

        How does the tax treatment of my annuity payments work?

        The total amount of tax you will pay on your annuity income will depend upon how much total income you have received during the year and the tax rates which are then applied.

        In the current tax year (2019/20) each UK resident receives a personal allowance of up to £12,500, which means if your total income is lower than this amount you pay 0% income tax.

        If your total retirement income, including any annuity payments, exceeds your personal allowance you are liable for tax at your marginal rate.

        The table below illustrates the different income bandings and the tax rates which apply for these amounts.

        Band Income Tax Rates
        Personal Allowance Up to £12,500 0%
        Basic Rate £12,501 – £50,000 20%
        Higher Rate £50,001 – £150,000 40%
        Additional Rate Over £150,000 45%

        It’s fairly common, once you reach retirement, to have a variety of different income sources, in addition to any annuity payments, such as:Taxation of annuity payments: examples

        • Basic state pension
        • Part-time employment
        • Other pension income

        The table below provides a number of different examples demonstrating how much tax may be liable on your retirement income and the effect annuity payments could have on the overall amount of tax you may be liable for.

        Other Retirement Income Annuity Income Total Income Marginal Tax Rate Income tax to pay
        £7,000 £4,000 £11,000 0% £0
        £10,000 £5,000 £15,000 20% £500
        £15,000 £15,000 £30,000 20% £3,500
        £45,000 £15,000 £60,000 40% £11,500

        These examples illustrate why it is important to consider the impact of annuity payments to your overall income and the total amount of income tax you may need to pay.In the top example within the table, the annuity payment has no effect on the tax due as the overall income is still below the personal allowance. However, in the bottom example, the annuity income pushes the total income into the higher rate band by £10,000 creating an additional £4,000 tax liability (40%).

        If you are able to live comfortably upon other sources of retirement income, ask an advisor whether it makes financial sense to defer taking any annuity withdrawals until they are absolutely required, in order to avoid paying any additional tax.

        If you’d like to find out more about how annuity payments are taxable, based upon your own pension fund and personal circumstances give us a call on 0808 189 0463 or get in touch so we can arrange for an expert to speak with you directly.

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        Are annuities taxable to beneficiaries?

        Yes, possibly, however, this really depends upon the type of annuity that has been put in place. For example, a standard lifetime annuity on a single life basis will stop paying an income when you die and does not offer the option for any outstanding pension funds to be returned to a beneficiary.

        However, there are certain types of annuities that offer a number of death benefit features, such as:

        For a joint-life annuity, the income simply passes over to a surviving spouse in the event of one life assured’s death and will, therefore, form part of their overall income for tax purposes. As such, there is no ‘inheritance’ and the annuity policy will cease upon the death of the surviving spouse.

        A guaranteed annuity provides an income for a fixed period of time. If the life assured passes away during the term, then a nominated beneficiary will receive the income for the remaining period.

        A value protected annuity provides a return of the original amount invested to a nominated beneficiary in the event of the policy owner and life assured’s death.

        Due to the death benefit features provided by both a guaranteed and value protected annuity, there may be potential tax implications for a beneficiary.

        How are annuities taxed to beneficiaries?

        The taxation of any annuity which has been inherited by a beneficiary will be dictated by the age of the original owner upon their death.

        Annuity Owner Dies before the age of 75 Annuity Owner Dies after the age of 75
        Beneficiaries will receive all the annuity payments free of income tax Beneficiaries will pay income tax on all annuity payments at their marginal rate

        Is an annuity subject to inheritance tax?

        Inheritance tax is not typically liable on any annuities in the UK. In the event of the original owner’s death, a beneficiary can receive benefits from an annuity in the form of an income or lump sum payment which may be subject to income tax (as outlined above) but not inheritance tax.Is an annuity subject to inheritance tax?

        An annuity provider holds the funds within a discretionary trust, therefore, when the owner of an annuity dies these funds do not form part of their estate.

        If you’ve recently inherited an annuity, or are aware that you’re a named beneficiary of one, it’s important to understand what potential tax consequences may arise as a result. This is where we can help.

        The advisors we work with can provide a wealth of knowledge in all areas relating to the taxation of annuities both during your retirement and upon death. If you get in touch we can arrange for an expert to contact you and discuss further.

        Speak to an annuities expert

        Annuities are a popular option for many people as a means to bolster their retirement income, however, it’s important to understand how taxes are applied on the annuity you choose both for the income you receive and any death benefit features included.

        This is where we can help. The advisors we work with can help you better understand the full tax treatment on any annuities you wish to buy after you reach retirement.

        All advice is free and any information is always given in the strictest confidence.

        Call us on 0808 189 0463 or make an enquiry to get started.

        Ask A Quick Question

        We can help! We know everyone's circumstances are different, that's why we work with brokers who are experts in pensions Ask us a question and we'll get the best expert to help.

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        Richard Angliss

        Richard Angliss

        Finance Expert

        About the author

        Richard Angliss has made a career in financial services which stretches over 40 years.

        His early career was spent learning about the various financial products and applying them to prudent advice, working for one of the largest life assurance and investment firms. After that he joined the financial services arm of a very well-known firm providing independent advice to their 8 million customers.

        For the last 20 years he has been involved in building software solutions that help Advisers and clients work together to achieve good financial outcomes and helping to set up three independent advisory firms. He also has written many articles for financial services publications and provided commentary for newspaper journalists.

        At an early stage in his career he realised the great satisfaction that comes with being able to help people achieve their goals and protect their families. “Regulation of financial services has hugely impacted on ensuring people get appropriate advice. The issue these days is access to that advice and just as importantly regular reviews to make sure that everything stays on track”.

        With the growing development of online resources such as Online Money Advisor he sees a great future for people to access advice to make their pension and investment work harder for them.  Plus, of course, to ensure they have insurance products in place that will be required when unforeseen events happen.

        He knows getting that balance right is crucial to prudent financial planning and the wellbeing of individuals and their families.

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