Case study: Annuity Income

There will be a number of individuals with older pension plans, containing guaranteed annuity rates or guaranteed minimum pensions that look attractive considering the rates available now. A general trend for most individuals has been to increase flexibility and the position on death, at the expense of these guarantees.  For some individuals however there may be the option where the use of a guarantee on an older pension plan can tie in with basic retirement objectives and provide some tax efficient planning, at least over a short period of time.  The following example looks at this in more detail.


The client is 62 and had retired from his employers defined benefit scheme at 60, taking a pension of around £3,000 per annum. He does some self-employed part time work earning around £2,500 per annum, and has no real plan to stop this while he still enjoys it and is fit enough to continue with it.

His wife is already in receipt of state pension and a teachers’ pension providing a combined £15,000 per annum and these sources of income at this time are sufficient to meet expenditure needs, particularly as his full state pension will also come into payment in the not too distant future.

In addition to the pension in payment, he has a couple of uncrystallised pension arrangements with Aviva and Phoenix Life. He has not to date been pressed to look into these as the income elsewhere is meeting retirement needs.

He does however now need a capital lump sum for a few expenditure needs, namely a holiday and assistance with his daughters planned wedding. As him and his wife only have capital consisting of a £7,000 emergency fund, he wishes to consider his uncrystallised pensions to meeting this.

The Aviva plan is a stakeholder pension with a value of circa. £85,000 and the Phoenix Life a personal pension with a value of £47,000. The Phoenix Life plan has an enhanced entitlement to tax-free cash now worth just under 55% of the fund value at £25,596. To get this lump sum he would however have to purchase an annuity with the remainder. To take just the tax-free cash and designate the rest to drawdown, he would have to transfer and forfeit the enhancement.

The option to consider is taking the enhanced tax-free cash and selecting a level annuity with a 10-year guarantee and 50% spouse benefit. Based on his age and the rate offered, he will receive £774.72 per annum, paid monthly at £64.56.

As the income falls within his personal allowance, he can receive this tax-free. As there is no immediate need for the additional income, he can contribute this to the Aviva stakeholder plan he has.

These contributions of £64.56 per month will receive basic rate tax relief (as they fall within the higher of his earnings or £3,600 gross per annum) and each contribution will be grossed up to £80.70, (or £968.40 considered over 12 months).

This effectively provides ‘free’ tax relief and helps create further pension savings for later use, including more of a PCLS.
Most importantly, this secures the immediate enhanced tax-free cash of over £25,000 which is only available via an annuity purchase anyway. This makes the fact that an annuity needed to be purchased less of an issue as there is scope to gain extra from it at least in the next few years.

He can ideally continue to contribute the annuity to a pension while he pays no tax on the annuity itself but even if it became subject to basic rate tax, the contributions can continue (now being tax neutral and illustrated in the table below) for the provision of further PCLS in the future.

Contributions from the annuity:

Position Gross income Net Income Contribution Contribution with tax relief Difference
Nil Rate £64.56 £64.56 £64.56 £80.80 +£16.24
Basic Rate £64.56 £51.65 £51.65 £64.56 £0

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