Savings & Investments Part 5: Purchased Life Annuities (PLAs)
Purchased life annuities can be a very effective way of providing income in retirement, but they suffer from the same disadvantages that all lifetime annuities suffer from: Once you’ve paid your money, you can’t get at it (other than the income payments you’re entitled to).
If access to capital while you’re alive, or passing capital on when you die, are important, then these products aren’t likely to be right for you.
On the other hand, if your primary concern is to maximise your income while you’re alive, without any investment risk, this could be the right product for you.
There are several advantages purchased life annuities have over other products:
- A guaranteed income for life. Like all lifetime annuities, a purchased life annuity provides a guaranteed income for life, however long you live.
- Tax benefits. Each income payment you receive is made up of two elements: A return of part of the money you paid originally to buy the annuity and the interest or growth the insurance company has achieved by investing your money. (There is a third element but this is dealt with separately below). The Government assumes that the money you used to buy the annuity has already been taxed, even if it hasn’t, so that part of each payment that represents a return of your own money is tax free.
- Mortality credit. In the previous bullet we said that each payment is made up of two elements. Actually, there’s a third element: A purchased life annuity also benefits from what is called ‘mortality surplus’. These so called ‘surpluses’, that arise from people dying early, aren’t used to swell insurance companies profits. Assumptions are made by the company about how many people will die early and the ‘surplus’ is used to boost the rate you’re offered.
So if you aren’t put off by some of the disadvantages of annuities, this may be a worthwhile product for you.