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2.2.13 Annuities

  • Annuities convert capital to income.

  • An annuity is a periodic annual payment; in practice, payment will often be monthly or quarterly, may be fixed, increasing or even variable, and may be payable 'in advance' or 'in arrears'. These latter terms mean that once the payment frequency is agreed, payment is made either at the beginning of the period, (in advance), or at the end of the period (in arrears).

  • May be payable immediately or be deferred.

  • Payments may be for a fixed period or may continue for life.

  • Generally, there are no underwriting requirements as with life assurance, because full payment is made at the start of the contract, and longevity is not easily determined for specific individuals.

  • Annuities come in two broad categories:-


    1. compulsory purchase annuities (CPAs), purchased by pension funds to provide retirement income, and taxed as PAYE, and
    2. purchased life annuities (PLAs), purchased by private investors, payments comprising part taxed interest (as investment income), part untaxed return of capital.

  • There are a wide variety of annuities, the following being the ones most usually encountered:


    1. Annuity Certain (or Guaranteed Annuity)
      Paid for a fixed period, whether the purchaser or beneficiary is alive or not. Useful for school fees provision. Generally treated as a PLA.
    2. Capital Protected Annuity
      Total payments are guaranteed to equal purchase price, any underpayment on death being returned as capital and not taxed. Generally treated as a PLA.
    3. Compulsory Purchase Annuity (CPA)
      Purchased by pension funds to provide the retirement income for scheme members, and can be immediate or deferred. Taxed as earned income.
    4. Contingent Annuity
      Provides an income in the event of a particular situation coming about e.g. providing an income for B in the event of A's death.
    5. Deferred Annuity
      Purchased by a lump sum or series of payments to commence at a future date after a specific length of time i.e. the deferred period. Often used where company group pension scheme members leave a pension scheme prior to retirement to secure payment of accrued pension benefit at normal retirement date.
    6. Equity Linked
      Where the underlying value is unitised so that the annuity may withdraw some units each payment period, the balance remaining in the fund to go up or down with the fund value.
    7. Escalating
      Where the payment increases by a fixed amount over the payment period.
    8. Guaranteed
      Where payments are made for life, but if the annuitant dies within a specified period, the payments continue for the balance of that period.
    9. Immediate Annuity
      One that starts after payment of the purchase price.
    10. Joint Life Annuity
      Payable until the death of the first of a 'group' of annuitants, often husband and wife.
    11. Last Survivor Annuity
      Payable until the death of the last of a 'group' of annuitants, often husband and wife.
    12. Purchased Life Annuity (PLA)
      An annuity purchased by an individual from private funds, and paid as part interest and part return of capital, the balance of the two parts depending on the age of the annuitant. Tax is levied only on the part representing interest payments.
    13. Reversionary
      Where an annuity commences on the death of another.
    14. Temporary annuity.
      One which is paid for an agreed period, or to earlier death.

  • There is no investment risk attached to annuities, as almost all annuities have guaranteed returns. On the other hand, there is unlikely to be any access to the invested capital.

  • It is clear that, provided permanent or temporary loss of access to capital is acceptable, annuities are ideal for those who require a fixed or increasing income for a fixed term or for life. This may be an only source of income, or it may be to top up existing income

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