Tax and annuities

When you’re planning your retirement and budgeting for the future, there’s one thing that’s easy to overlook: tax.

Your annuity payments are taxable, just like other income. In this guide, we'll break down how it works and help you understand how much you’ll have left to spend.

How is an annuity taxed?

HMRC treats the income you get from an annuity as ‘earned income’. That means it’s taxed in the same way as income you earn from employment.

When you retire, your personal allowance stays in place. This is usually set to £12,570, so you won’t pay tax on any income up to this amount. If your income goes over this threshold, it’s taxed at the relevant tax rate. We'll explore more on tax rates below.

Is all of an annuity taxed?

No, not all of an annuity is taxed. When you buy an annuity, you can take up to 25% of your pension pot as tax-free cash. The remaining amount used to buy your annuity is taxed as earned income.

Are annuities taxed at source?

‘Taxed at source’ means that the tax is already taken off before you receive your income. Annuity payments are taxed at source, which means the income you receive is all yours. The tax has already been taken off before it reaches your bank account.

Annuity tax rates 

The rate of tax you’ll pay on your annuity income depends on your total income.

To work out your total income, add up all the income you receive in a year. This can include:

• Annuity payments
• State pension
• Other pensions
• Salary or self-employment income
• Rental income 
• Interest from savings (above your saving allowance)

Once you have your total income, check which tax band you fall into to see how much tax you’ll pay. Tax bands the same whether you live England, Wales and Northern Ireland, however if you live in Scotland, your tax bands are different.

England, Wales and Northern Ireland tax bands

Scotland tax bands

Good to know: Tax rates and thresholds can change over time. You can find out more about income tax rates at gov.uk.

How it works in practice

Let’s say your yearly income is:

Your total income is £24,000, which falls into the basic rate tax band of 20% in England, Wales, Northern Ireland and Scotland.

To calculate how much tax you’ll pay:

1.      Work out your taxable income

Take your total income and subtract your personal allowance to get your taxable income.

2.      Work out your tax to pay

Take your taxable income and multiply it by the rate to get your tax to pay amount.

So, a total yearly income of £24,000 means you’ll need to pay £2,286 in tax, leaving you with £21,714 to spend. This is only an illustration. Your own figures will depend on your total income, your tax code and where you live.

How are different annuities taxed?

Not all annuities are taxed the same way, it depends on which type you choose.

Lifetime and fixed term annuities

In terms of tax, lifetime and fixed term annuities work in the same way. All the income you earn from your annuity will be taxed as earned income.

Learn more about our Lifetime Annuity and Fixed Term Income Plan.

Purchased life annuities

This type of annuity works differently: you’ll only be taxed on a portion of your income.

This is because your income is split into two elements:

• The capital element is a return of the original lump sum you paid and is free from tax.
• The income element is any income beyond the original lump sum, such as interest. This is taxed as savings income.
• This means that part of your income is treated as a return of your money that you used to buy the annuity with - which isn't taxed.

Learn more about our Purchased Life Annuity.

Learn more about annuities 

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