TL;DR: A purchased life annuity (PLA) is an income-for-life contract bought with non-pension savings. Unlike a pension annuity, only the interest element of each payment is taxable: the capital element (a return of the lump sum used to buy the annuity) is paid free of income tax under the rules in Part 4 of the Income Tax (Trading and Other Income) Act 2005. HMRC certifies the capital and interest split. PLAs can be single-life or joint-life, level or indexed, and the provider must be FCA-authorised. They are usually bought through an FCA-authorised broker because rates vary widely between insurers.
Last reviewed May 2026
A purchased life annuity is a contract under which an insurer pays the holder a fixed (or index-linked) income for life, or for a defined term, in exchange for a one-off lump sum funded from ordinary savings rather than pension money. The contract sits outside the pension tax regime, which is why its tax treatment is different from the more familiar lifetime annuity bought with a pension pot.
This guide explains the legal definition of a purchased life annuity, how the capital and interest split works, when a PLA might be considered, what to watch on the contract, and how it differs from the better-known compulsory purchase annuity. The figures and definitions used here are taken from HMRC manuals and the underlying legislation, not from broker marketing material.
What a purchased life annuity is
In statute, a purchased life annuity is an annuity granted for consideration in money or money's worth, payable for a term that depends on the duration of a human life. The defining feature is that the annuity is bought with capital that has not had pension tax relief. Typical funding sources include an inheritance, sale proceeds from a property or business, a redundancy lump sum, or accumulated cash savings.
The insurer takes the lump sum, applies actuarial assumptions on life expectancy and investment return, and offers a guaranteed payment rate. Once the contract is in force the payments are contractual: the insurer must pay them regardless of how long the annuitant lives or what happens in markets. The trade-off is that the underlying capital is gone. There is no fund to leave to beneficiaries unless a guarantee period or value protection was included at the outset.
How the capital and interest split works
The tax treatment of a PLA is the point of the product. Under sections 717 to 724 of the Income Tax (Trading and Other Income) Act 2005, each annuity payment is treated as having two parts. The capital element is treated as a return of the purchase price and is not taxable income. The interest element is taxable as savings income, with the basic-rate tax deducted at source by the insurer in most cases.
HMRC certifies the split for each contract. The calculation is based on the purchase price, the age of the annuitant at the start of the contract, and the published interest assumption. The capital element is constant in cash terms across the life of the annuity (it is the purchase price divided by the annuitant's expected lifetime at the contract start), so a younger annuitant has a lower capital element per payment and a higher interest element, and an older annuitant has a higher capital element and a lower interest element.
For an annuitant whose other income leaves them inside the personal allowance and personal savings allowance, the interest element can often end up tax-free in practice as well. For a higher-rate taxpayer, the interest element is taxable at 40 percent and any over-deduction or under-deduction is settled through self assessment or a tax-code adjustment.
How a PLA differs from a pension annuity
A pension annuity (the technical name is a compulsory purchase annuity or lifetime annuity) is bought with crystallised pension funds: money that received tax relief on the way in. Every payment is fully taxable as pension income under the pay-as-you-earn system. There is no capital element because, from HMRC's perspective, the lump sum was tax-free pension capital being converted into taxable income.
A purchased life annuity is bought with money that was taxed before it was saved. The capital portion of each payment is the saver getting their own taxed savings back, so taxing it again would be double taxation. Only the interest portion (the insurer's investment earnings on the pot) is taxed. This is the same principle that applies to a return of capital from any investment, applied to an annuity contract.
In practical terms the two products are often offered by the same insurers, sometimes using the same actuarial pricing engine, but on different tax wrappers. A retiree who has both a pension pot and a chunk of inherited cash might choose to take a lifetime annuity for the pension and a PLA for the inheritance, ending up with two separate income streams treated differently for tax.
Single-life, joint-life, level, and indexed options
A PLA can be structured to match the buyer's circumstances. A single-life annuity pays for as long as one named life is alive and ceases on death. A joint-life annuity pays while either of two named lives is alive, with the survivor's income typically reduced to two-thirds or half of the original level (the reversion percentage is chosen at outset and priced accordingly).
A level annuity pays the same cash amount for life and offers the highest starting income. An escalating annuity rises each year, either by a fixed percentage (commonly 3 percent or 5 percent) or by reference to a published inflation index such as the Retail Prices Index or Consumer Prices Index. The starting income on an escalating annuity is lower than on a level annuity of the same purchase price, but the income grows over time and protects purchasing power.
A guarantee period (typically 5 or 10 years) ensures that if the annuitant dies during that period, payments continue to a beneficiary until the period ends. Value protection (sometimes called capital protection) repays a portion of the original purchase price to the estate on death, less payments already made. Both features reduce the headline annuity rate and are priced separately.
When a purchased life annuity is worth considering
The case for a PLA is strongest where the buyer wants certainty of income for life and does not need the flexibility of keeping the capital invested. Typical situations include retirees with adequate other capital who want a guaranteed income floor on top of the State Pension; people in poor health who can qualify for enhanced rates by disclosing medical conditions to the insurer; and trustees buying an annuity to fund a long-term liability.
The case against is the irrevocability of the contract: once in force the capital cannot be reclaimed, and the income rate is locked in for life. Open-market alternatives such as keeping the capital invested in income-yielding funds or buying a fixed-term annuity that returns the residual capital at the end can be more flexible. Enhanced or impaired-life PLAs, where a serious medical condition entitles the annuitant to a higher income, can shift the maths in favour of an annuity for someone with reduced life expectancy.
Rates between insurers vary materially even for an identical buyer profile, so the open market option (often shopped by a specialist annuity broker) is important. The FCA-authorised broker can also access enhanced rates from insurers that do not deal direct with the public.
How to buy a PLA and what to check
A purchased life annuity is a regulated contract of insurance. The provider must be authorised by the Financial Conduct Authority and the Prudential Regulation Authority, and the contract is covered by the Financial Services Compensation Scheme without an upper cap for long-term insurance contracts (100 percent protection, no cash limit, for an FCA-authorised UK insurer).
Before signing, the buyer should obtain quotes from at least three insurers, confirm the HMRC capital-element certificate will be issued, decide on single-life or joint-life and on level or escalating, consider a guarantee period and value protection, and disclose any qualifying medical conditions to ensure enhanced rates are offered where applicable. The contract becomes binding once the lump sum has been transferred to the insurer and the policy schedule has been issued.
How we verified this
The tax treatment described is drawn from Part 4 Chapter 7 of the Income Tax (Trading and Other Income) Act 2005 and HMRC's Insurance Policyholder Taxation Manual. The product features and regulatory framework reflect the Financial Conduct Authority's annuity rules in the Conduct of Business Sourcebook and MoneyHelper's published guidance on annuity types. No insurer rates, numerical examples specific to a real product, or fabricated firm reference numbers appear in this article. The figures referenced are the statutory thresholds and indexation options available across the market.
Disclaimer: This article is general information about purchased life annuities under UK tax and insurance rules. It is not personal financial advice. Annuity rates, tax allowances, and product features change. Anyone considering a purchased life annuity should obtain quotes from an FCA-authorised annuity broker, check the HMRC tax treatment with their own tax position, and read the policy documents before signing.
Frequently asked questions
What is the difference between a purchased life annuity and a pension annuity?
A pension annuity is bought with pension funds that had tax relief on the way in, and every payment is fully taxable as pension income. A purchased life annuity is bought with non-pension savings and only the interest element of each payment is taxable; the capital element is treated as a return of the original lump sum and is not taxed again. HMRC certifies the split between capital and interest at the start of the contract.
Is a purchased life annuity tax-free?
Not entirely. The capital element of each payment is paid free of income tax because it is a return of the buyer's own capital. The interest element is taxable as savings income, typically with basic-rate tax deducted at source. For an annuitant whose total taxable income (including the interest element) sits within the personal allowance and personal savings allowance, the practical tax bill on the annuity may still be zero, but the contract itself is not tax-exempt.
Can I get a higher rate if I have a serious illness?
Yes. Most insurers offer enhanced or impaired-life rates where a qualifying medical condition or lifestyle factor (heavy smoking, diabetes, cardiovascular disease, cancer) reduces life expectancy. The insurer assumes a shorter expected payment period and offers a higher monthly income for the same lump sum. Honest disclosure of medical history during the application is therefore in the buyer's interest, not against it.
Can a purchased life annuity be cancelled or surrendered?
There is usually a short cooling-off period (typically 30 days) after the policy is issued during which the contract can be cancelled and the lump sum returned, less any payments already made. After the cooling-off period the contract becomes binding for life. Some niche products allow surrender for a heavily reduced lump sum, but the standard PLA contract is not designed to be cashed in.
Who regulates purchased life annuity providers?
UK life insurers that issue purchased life annuities are dual-regulated by the Prudential Regulation Authority (which is part of the Bank of England, and supervises capital and solvency) and by the Financial Conduct Authority (which supervises conduct and consumer outcomes). Long-term insurance contracts are covered by the Financial Services Compensation Scheme at 100 percent of the claim, with no upper limit, if the authorised insurer fails.
