Tax on annuities - income and capital component

[Benjamin]

Hi,

Reference: CMP, Ch6, p.7

Am I to understand from this that of each annuity payment, the policyholder pays tax on the income component and the lifeco pays tax on the capital component? The last sentence of first core reading paragraph ("This difference...") is quite convoluted - does it just mean "lifeco pays tax on capital component?"

 

[Lindsay Smitherman]

No-one pays tax on the capital component, as this just represents the return of the premium (in instalments) back to the policyholder within their annuity benefits.

The policyholder pays tax at their full marginal rate on the income component of BLAGAB annuities. Then, because this component has already suffered full policyholder taxation, the company can deduct this income component (for BLAGAB annuities) from the "I-E" tax calculation. This is done by including the income component in "E". [This makes sense because the income component of the annuity is effectively paid for out of the excess of investment return earned on the initial premium less expenses incurred.]

 

[Benjamin]

Yep make sense - thank you!
(and I guess that return of premium has been taxed anyway, because for a general annuity, the premium is paid out of earnings on which income tax was already paid by the individual - so essentially the annuitant pays tax on the whole lot but at different times...)

 

[Lindsay Smitherman]

Yes - you're absolutely right