If you buy a personal money back annuity, does it count as a pension and thus becomes IHT exempt?

07 October 2021

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Question by Philip

If you buy a personal money back annuity, does it count as a pension and thus becomes IHT exempt?


Answered by Andrew Neligan

Hello Philip,

There are two types of annuity; a pension annuity, which is purchased with an accrued pension fund (a Lifetime Annuity) and a Purchased Life Annuity (PLA), which is purchased with capital outside of a pension.

In both cases, you are giving up capital in exchange for an income. With the pension annuity, all of the income is assessable to income tax. Income tax is only paid once income from all sources exceeds £12,570 for this tax year.

A purchased life annuity is a mix of return of capital and interest. The capital element is not taxable, but the interest element is (depending upon total income in the year). The mix between capital and interest depends upon the life expectancy of the annuitant.

Thinking specifically about IHT, because you are exchanging capital for income under the PLA it is reducing the value of your estate. However, if the income received is not spent it will form part of your estate when calculating IHT on death.

With the pension annuity, the pension is outside of your estate for IHT purposes. However, when covered to an annuity the same issue may arise with income that is received but not spent.

One of the IHT exemptions is gifts that are regular expenditure out of income. In the case of PLAs, the capital element is not deemed to be 'income' in HMRC's definition so would not be included in this exemption (but may still be IHT exempt under the annual £3,000 gift allowance or as PET (the "7-year clock rule").

I hope this helps.

Andrew

Answered by

Andrew Neligan

Chartered & Certified Financial Planner.

Typically, I work with individuals and couples who have got to the point in their lives that they have important questions about money they want answering. They may be thinking about retirement in the next 5 to 10 years but they are worried they won’t have enough so they want to make sensible decisions now. Or, they really want to retire sooner, but either they don’t know if they can afford to, or they are afraid they will make decisions that they may later regret.