Deferred Annuities

We have already encountered the deferred annuity in personal pension plans. The deferred annuity is payable at some date, and may be purchased either by regular premiums or by a single payment. The rate of future income payable under a deferred annuity is normally fixed at the time of purchase. The buyer therefore stands to lose if interest rates are higher at the time when the annuity becomes payable than they were when he made the purchase. The converse also applies, since if interest rates are lower when the annuity becomes payable he will have acquired a higher rate of income through the deferred annuity than he could obtain at the time with an immediate annuity. However, the policyholder generally has the option of taking a cash sum in lieu of the guaranteed payment and he may use this to buy an immediate annuity at the best rates available in the market. However, taking a cash sum in these circumstances can produce a tax liability. Deferred annuities are little used by themselves, though they do form one element in the single-premium investments known as income bonds (see p. 112.)

Another rare type of annuity is the reversionary annuity. Here, the payments start on the death of a named person and are payable to another named person throughout their life. They were used by husbands to provide an income for their wives after their death but today are not very common, since life insurance is more effective.

Temporary annuities have a variety of uses. They, too, are found in single-premium investment packages, but may also profitably be used by individuals in some circumstances. They are payable for a fixed term or until the earlier death of the annuitant.

The usual use is to "fund" some liability for regular payments using a capital sum. Thus, an investment of a sum in temporary annuity can produce a regular income for 9 years which can be used to pay the premiums on a qualifying life insurance policy. The capital, at the end of 10 years, has been converted from a taxable investment into a tax-free one within the confines of a life insurance policy. This type of exercise is particularly attractive to those with capital and high income tax liabilities.


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Annuities Example 27

Mr and Mrs Diamond, both aged 75, have only a fixed pension in addition of the State old-age pension. But they do own their own house, now worth £1115,000. They raise a loan of £500,000 on the house and invest the money in a joint life and survivor annuity.

This produces an income of £1900 a year (after income tax on the interest portion of £170). The loan interest (at 7% on £500,000) amounts to £1700, which is deducted from the annuity payment, leaving £1200. This sum is paid out in quarterly instalments.

But Mr and Mrs Diamond... see: Annuities Example 27


Of interest