Buying a pension lifetime annuity is one of the options available to you to provide a regular income in retirement. In exchange for part, or all, of your money purchase pension savings, a lifetime annuity will provide an income for life, meaning you can’t outlive your money.

But how is an annuity taxed?

How is an annuity taxed?

Your annuity income payments are classed as ‘earned income’, and are subject to income tax, just like the salary you will have received during your working life.

In retirement, just as when you were employed, you get an income tax threshold, known as your personal allowance. For 2021-22, the personal allowance is set at £12,570, meaning you do not normally pay tax on any income up to this amount. Beyond this amount, you will need to pay income tax at your marginal rate.

In addition to income tax, if the total value of your pension fund(s), when taken, exceeds the standard lifetime allowance, you may have additional charges to pay. The lifetime allowance is the maximum amount of tax-relieved pension savings that an individual can build up over their lifetime.

What rate are annuities taxed at?

How much tax you’ll pay will depend on your income tax band, which in England, Wales and Northern Ireland is set at 20% for a basic rate taxpayer, going up to 40% for higher rate taxpayers and 45% for additional rate taxpayers. If you live in Scotland, income tax bands work slightly differently.

Bear in mind, HMRC will determine your income tax band based not just from your annuity income; they will also take into account other sources, such as your state pension, any income you receive from property rentals, dividend income etc. - all added together to determine your tax band.

In addition, your income (and any tax-free cash taken) may affect any means tested benefits you receive.

How are annuities taxed to beneficiaries?

When you take out an annuity, you will have the option to add death benefits that could mean your income or remaining pension funds will be payable to your chosen beneficiaries or estate after your death.

These death benefits can include value protection, a guarantee period or a joint life annuity. If you do not add any death benefits to your annuity, there will be nothing payable to your loved ones after your death.

If you have added death benefits and are within the terms agreed at outset, any money left to your estate may be taxed, though it depends on how old you are when you pass away:

  • Before age 75: Lifetime pension annuity payments from value protection, guarantee periods and joint life annuities are tax-free if you as the original annuitant are under 75 when you die.
  • Age 75 and over: Funds due under value protection, guarantee periods and joint life annuities are subject to income tax at the marginal rate of the recipient if the original annuitant is 75 or over when they die.

Payments under a guarantee period may be subject to inheritance tax if the payments are included in the annuitant's estate and not assigned to a trust. If the annuity amount takes the value of the estate above the £325,000 inheritance tax threshold, tax charges may apply.

We have based this information on our current interpretation of UK tax rules (August 2021). Tax rules and regulations are subject to change and how they impact you will depend on your personal circumstances.

Is all of an annuity taxable?

You can normally take up to 25% of your pension savings as a tax-free lump sum, leaving the remainder to purchase your annuity. The annuity income you receive after this will be subject to income tax through the pay as you earn (PAYE) system.

How much income will I get from my annuity?

The amount of income you receive from your pension annuity will depend on a number of factors, such as the size of your pension fund, the features you add to your annuity and your age at the time of purchasing.

  • The size of your pension pot. As you may expect, the bigger the pension fund used to purchase your annuity, the more income you’ll normally receive.
  • How old you are when you buy your annuity. Purchasing your annuity at a younger age may mean the annuity provider has to pay you an income for longer, resulting in a lower income.
  • Annuity rates at the time you buy. Annuity rates go up and down depending on market conditions. If annuity rates are on the up when you apply for your annuity, you may be offered a higher income than if rates were low.
  • Your health and lifestyle. You may be able to get an enhanced annuity if you have certain medical conditions, are overweight or smoke.
  • How you choose to take your annuity payments. You will usually receive a higher annuity income if you choose to take your annuity payments in arrears, rather than in advance. Likewise, if you choose to receive an annually increasing income you will receive a lower annuity payment in the initial years.
  • Your payment frequency. You may receive more income by choosing to be paid annually in arrears rather than monthly or quarterly.
  • If you choose to add death benefits. Death benefits can include value protection, a guarantee period or a joint life annuity, each aim to leave something behind after you die. Adding these features to your annuity will likely reduce the income you receive.

Find out how much annuity income you could get

If you would like to see how much annuity income you could get, our online form can help you to compare annuity rates from all providers in the annuity open market.

If you’re ready, compare annuity quotes now.