US versus UK annuities

A big selling point of annuities is that there is no tax to pay while the money remains untouched. However, with this annuity there is some small print to be read. The rates paid on annuity rates are falling all around the world, but there is still a lot to be understood about the rates of tax you will pay based upon how you receive your annuity and, indeed, in which country you invest. Here in the US, if you were to take your annuity in one lump sum you could be at a huge disadvantage when it comes to tax. The amount you invested would remain untaxed as the assumption is that tax would have already been paid on that sum of money before placing in an annuity. The downside is that the money you have gained will be subject to tax for each amount of interest in the year it was gained, which means that you will pay as if the interest were “ordinary income” – so essentially you wouldn’t get any tax breaks! Conversely, in the UK, part of the interest is counted as a repayment on the lump sum invested; so only part would be subject to taxation. In the UK, you could even get that tax back if you are not a tax payer and starting rate tax payers can reclaim half the tax deducted. A better way generally is to annuitize - that is that you take an amount each month as a “wage”. This way the US government will discount the part that was your initial payment and further they will include an “exclusion ratio” in which you won’t pay any tax. The exclusion ratio is at 49.4% and any interest included in this will be excluded from tax. You will only be taxed on the amount of interest after that ration has been deducted. If you need more information on annuities, the Guardian covered the basics pretty well – but make sure you talk to a professional before you start throwing your money around!
According to Scott Mullen, “Annuities rates have fallen in the UK and the US in recent years due to the current economic climate. The banking crisis has led to record low interest rate on both sides of the Atlantic which is having a knock on effect on current annuity rates. This is because annuity providers use secure types of financial products such as corporate bonds and government bonds to provide the income for their annuity book as these types of investment are usually safe and low risk.
“When government and corporate bonds are introduced to the market they have to offer a competitive rate of interest to attract investment, but due to the lack of an attractive alternative form bank interest rates the yield offered have fallen proportionately. The economic crisis is having a harder impact on UK rates as the annuity rate offered for a 65 Year old male is 5.75% compared to 6.8% in the US. This could be as a result of UK qualitative easing which is putting additional downward pressure on UK government bond yields.”