Taking a Closer Look at Lifetime Annuities

In our last four articles on pension decumulation, we took a look at the drawdown and uncrystallised funds pension lump sum (UFPLS) retirement options, as well as the money purchase annual allowance, and the death benefit rules. In this, our last article in this series, we take a look at lifetime annuities.

A lifetime annuity is the most common type of annuity purchased from a defined contribution fund. It provides a guaranteed income for life, and for many years was by far and away the most popular way to take a retirement income. However, since the introduction of pension flexibilities in 2015, there has been a shift from annuity purchase to other more flexible options, despite government efforts to make annuities more appealing.

Breathing life into lifetime annuities

Prior to April 2015, the main drawback of lifetime annuities was their inflexibility. In order to address some of these issues and to breathe new life into annuities, several changes were made alongside the pension flexibility measures brought in on 6 April 2015.

The government allowed the payments received from a lifetime annuity to go down (as well as up) by amounts in excess of those previously explicitly permitted in regulations.

The requirement to limit the minimum guaranteed period to 10 years was also removed. This, however, only applies to lifetime annuities set up on or after 6 April 2015 and not to those already in existence prior to that date. Transferring from a pre-6 April 2015 annuity into a new annuity won’t solve this issue for pre-6 April 2015 annuitants, as annuity transfers now have to be on a like-for-like basis, which wouldn’t be the case if the receiving annuity offered greater flexibility.

Also, prior to 6 April 2015, it was not possible to commute the income payments, payable under a guarantee period, for a lump-sum payment. However, since 2015, this has been possible for lifetime annuities (and scheme pensions), with a lump sum limit of £30,000 per scheme.

A further change removed the restriction of the survivor of an annuity having to be a dependant of the member; instead, a nominee’s annuity could be purchased at outset.

Death benefits

Annuity guaranteed periods ensure the annuity is paid out for the chosen guaranteed period even if the member dies within that period. Where the income payments under an annuity guarantee period started on or after 6 April 2015, the tax treatment of the income received is as follows:

• Where the annuitant dies before age 75, any income received by the beneficiary is free of income tax.
• Where the annuitant dies aged 75 or over, any income received by the beneficiary is taxed as the beneficiary’s pension income under PAYE.

Annuity protection lump sum death benefits or value protection allows a member to protect all or part of their fund. The maximum annuity protection is the difference between the total fund used to buy the annuity and the income already received before death.  The rules surrounding annuity protection lump sum death benefits have not changed since 6 April 2015, but the tax treatment is now as follows:

• Where the annuitant dies before age 75, the lump sum payment is not subject to tax, as long as it is paid within the two-year window following their death. If the payment is made outside of the two-year window, then they will be taxable at the marginal income tax rate of the recipient.
• Where the annuitant dies aged 75 or over, the lump sum payment is taxable at the marginal income tax rate of the recipient (payments to a trust are subject to a 45% tax charge).

Over to you!

Try the lifetime annuity exam question below (from our R04 mock paper):

Alan used his £300,000 pension fund to buy a pension protected annuity. The annuity was £18,000 p.a. payable annually in arrears. Alan died age 72, having received 12 payments to that point. The annuity protection lump sum his dependants would receive is:

1. £54,600.
2. £84,000.
3. £37,800.
4. £126,900.

The answer is below.

If you’re studying for your CII R04 exam, grab our free taster to try out one of Brand Financial Training’s mock exam papers for yourself.  Click the link to download the R04 mock exam taster now!

Alternatively, you can download the taster for AF7 or J05 if one of those exams is causing you to lose sleep.

Related Articles:

Pension Flexibility – The Drawdown Regime

A Look at the Uncrystallised Funds Pension Lump Sum (UFPLS)

Learning About the Money Purchase Annual Allowance (MPAA)

Pensions and Death Benefits

Answer B: The maximum annuity protection lump sum is calculated as follows: Fund used to buy annuity – gross payments paid = £300,000 – (£18,000 x 12 = £216,000) = £84,000 As Alan was under 75 when he died no tax is payable.