IPTM4100 - Purchased life annuities: background

The meanings of ’annuity’ and ’life annuity’ are discussed at IPTM1130 and IPTM1135, and there is more detail at IPTM4220. The judicial view of a life annuity is that the purchaser purchases a pure income stream with a capital sum - see the quotation from Watson B’s judgment recited at IPTM1130.

This view does not, however, reflect the commercial reality. Namely that each annuity payment comprises a return of part of the capital plus a sum reflecting, in economic terms, interest. Various attempts were made to circumvent the legal approach.

The first involved making a series of advances, instead of annuity payments, extinguishable against the capital sum eventually due on death. This device was countered by legislation in 1949 that became ICTA88/S554, though that section has now been repealed because of the overlap with ITTOIA05/S501. The second approach involved use, not of a life annuity, but an annuity certain - see IPTM4200- which the Courts have held is divisible between capital and income elements. The annuity certain was issued first, followed by a deferred life annuity, whose cost would be lower as the subject’s age had advanced.

In 1956, following the 1954 Report of the Committee on the Taxation Treatment of Provisions for Retirement, legislation was introduced that made such devices unnecessary. It provides for the creation of what ICTA88 calls a ‘capital element’, and ITTOIA05 an ‘exempt sum’, or ‘exempt proportion’, depending on the type of calculation involved, see IPTM4310. It reflects the amount of exempt capital comprised within each of the annuity payments. In broad terms, the exempt capital amount is obtained by dividing the purchase price of the annuity by the subject’s life expectation, determined according to prescribed mortality tables.

This Chapter explains the legislation governing the exemption in detail, and begins by looking at different types of annuity.