An annuity is an archaic term for an annual income although most are now paid monthly. An annuity is what you buy with your pension fund. Annuities can be one of two types. In effect you exchange a capital sum of money for an income. The level of income will be set at outset by the annuity provider, and it is guaranteed for your life time. Annuity rates are linked to long term gilt yields. The death benefit associated with the annuity will depend on the style of annuity bought, which may be single life (no spouses benefit) or joint life with a spouses benefit of 50% or 66%. Annuities can be index linked to give a hedge against inflation. Adding indexation and spouses benefits can reduce the initial payment by up to 40% when compared with a single life version :
Purchased Life Annuity
Compulsory Purchase Annuity
Purchased Life Annuity (PLA)
You may use any of your capital from any source at any time to buy an annuity. The funds do not generally come from a pension plan but are used to provide a guaranteed income. There is a distinction between interest and return of your capital within the annuity payment that allows you to make a tax reclaim for the return of capital element. Historically when annuity rates were 12% per annum these were popular vehicles. Rates are much lower now.
Compulsory Purchase Annuity (CPA)
The source money for CPA’s comes from pensions. There is deemed to be no return of capital. You can use your pension fund to buy your annuity from any of the providers not necessarily the one your pension is with if you can get a better return elsewhere.
CPA’s are guaranteed however rates are currently low.
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