Purchased Life Annuities: How Do They Work?

Annuities are commonly associated with retirees who use them to transform their pension savings into a steady income during retirement. But did you know that anyone can benefit from annuities? Whether you’ve received an inheritance, sold a property, or simply saved up a lump sum over time, you can purchase an annuity with that money. This type of annuity is called a purchased life annuity (PLA).

What is a purchased life annuity (PLA)?

A PLA offers you the opportunity to invest a lump sum of cash and receive a consistent, guaranteed, and tax-efficient income in return. This income can be provided for a set period or for your entire lifetime, depending on what your financial goals are and how much you have. It’s important to note that a portion of your income won’t be subject to taxes, as it’s considered a ‘return of your lump sum’ ensuring you aren’t taxed twice.

When considering PLAs and how they fit into your financial plans it can all seem a bit complex. Like all annuities, your money is invested in safe assets like bonds. The interest earned is used to pay your income, like receiving a wage from your investment. You’re essentially investing your money with an insurance company, and they then promise to pay you back in smaller, regular amounts with the goal of achieving a higher overall return.

What’s the difference between a pension annuity and a PLA?

PLA’s have all the same options as an annuity, though unlike a regular annuity (where you’d typically buy at retirement age with your pension) the age required to buy a PLA ranges from 35 to just under 95. There are also some differences in how they are treated for tax purposes, which you’ll learn more about below.

What are the pros and cons of a PLA?

The Pros

As a purchased life annuity lets you convert your money into a regular income with added interest, this option has become increasingly appealing in recent years due to inflation eroding the value of savings. In addition a PLA, like other annuities, can generate an income that can last your entire life or a fixed period, helping you to safeguard yours and your family’s future.

There can be tax benefits to buying a PLA too, since part of it will not be taxed as income. To learn more about this, jump to the section below: ‘How is a purchased life annuity taxed?‘.

The Cons

All that being said, there are some potential drawbacks to consider. If you need flexibility or immediate access to your funds then this wouldn’t necessarily be the best approach for you. A minimum lump sum is also typically required, with the specific amount varying among different providers.

Can PLAs be tailored to your needs?

PLAs offer some flexibility similar to regular annuities. You have options like enhancing your annuity rate, ensuring payments continue to a spouse after your passing, or even indexing the annuity to keep up with inflation. These options give you the freedom to customise the annuity to suit your own circumstances.

How is a purchased life annuity taxed?

When you buy a regular pension annuity, you’ve likely received tax relief on the contributions you made over your working years. This means the income you receive from the pension is taxable. But with a purchased life annuity, the money you’re using to buy it has already been taxed in some form, whether through inheritance tax, income tax, or other taxes.

As a result, a portion of your purchased life annuity isn’t taxed as income. Instead, it’s treated as a tax-free return of your initial investment.

Further Support with Purchased Life Annuities

It’s important to remember that the best financial decisions are tailored to your situation. In addition, you can only buy an annuity once and there’s no changing your mind afterward. So, make sure it’s the right choice for you. The income you’ll receive and the setup charges can differ a lot between options so shop around.

To help you make the best decisions, in line with your future plans, it’s always worth speaking to a professional pension advisor who can review your pension savings and offer personalised advice. If you’re ready to take the next step, you can book a free, no-obligation phone call with one of our advisors using the button below.