Annuity death benefits and tax
Annuity death benefits, in effect have the same tax benefits as flexi-access drawdown, and other types of pensions which have not been used to buy an annuity. Tax might or might not be payable depending on when the annuity holder dies, in a nutshell the death benefits are tax-free if death occurs before age 75, and subject to tax if death occurs after age 75.
Spouse's pension - suppose the annuity has a annuity payment of £400 per month. This is a 50% spouses pension. The annuitant (the person receiving the annuity) dies at age 70, and the income now drops to £200 per month for the benefit of his spouse. As death occurred before age 75, the £200 per month is paid tax-free, regardless of the spouse's income.
If the annuitant in this example died at age 76, the the £200 per month is then added to the spouses other income and taxed as her income.
Guarantee Period - again this works in exactly the same way as the spouses in terms of tax. And under the new rules the old maximum of 10 year has been removed. Supposed for example an annuity is £400 per month, and had a 30 year guarantee, when it started when the annuitant was 60. He dies aged 65 (five years after the contract started). As death occurred at age 65, the new income will then continue for another 25 years. The income is paid tax-free.
Supposed however, the annuitant in the above example dies at age 76, then the income again would continue for another 14 years. However, the recipient (wife or grown up child) would receive the £400 per month. This time as death occurred after age 76, the £400 is now added to the income of the recipient and taxed as income at their highest rate.
Value protection - this is probably the least common type of death benefit. However, this may change as it is effectively a money back guarantee, and potentially tax free. Again the age of death is the key point.
Let's say an annuity was bought with a fund of £50,000. It pays out £3,000 per year, and has 100% value protection. The annuitant takes it out at age 65, and dies after 5 years. So, £50,000 was "invested" and £15,000 (5 x £3,000) has been paid out. The death benefits are £50,000 - £15,000, meaning that £35,000 is paid out tax-free.
If death had occurred after age 75, then the £35,000 is then paid out. In 2015/2016 tax year this would be taxed at 45%. From 2016/2017 this payment would be taxed at the recipients higher marginal rate (added to their other taxable income).
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