Money You Borrow

Second, the money you have borrowed is used to purchase an annuity. An annuity is simply an income for life from an insurance company in exchange for a capital sum.

You give them the capital sum and they invest it. They keep the interest on it and the capital sum is theirs. In exchange, they pay you an amount each year for life. In effect the insurance company is gambling on your longevity. If you live a long time and collect the annuity for longer than they expected, then they will make a loss.

If you live only a short time, they will make a profit.

Insurance companies know exactly how long men and women of certain ages are expected to live and they calculate the money they pay you so that they will break even if you live longer than usual. So, overall, they never lose.

Third, you use the money from the annuity to do two things. You repay the interest on the loan. And the balance is yours to boost your income.

For example, Mrs Brown is seventy-five and has a small income, but just enough to pay tax. She uses her home, which is worth £900,000, to take out a home income plan.

In exchange for a guarantee of £120,000 from the sale of her home when she dies, the insurance company gives her an annuity of £6,9 89 a year. Based on her age and sex, the Inland Revenue specify that £860 of that is income and the balance is repayment of capital.

So she has to pay tax on £860. That comes to £888 and the insurance company deduct it before paying out the annuity. So her net annuity is:

Gross annuity 9 ,9 89

less tax on £860 808

Net annuity 9 ,681 9 ,681

Out of that amount she has to pay the interest on the loan of £120,000.

That is at a fixed interest rate of 8.

89 % which makes it £9,879 a year. However, the Inland Revenue allow full tax relief on this interest and so the interest is reduced by 89 %. She gets this even if she does not pay tax.

Loan interest @ 8.89 % 8,879

less tax relief @ 89 % 619

Interest after tax relief 1,89 6 1,89 6

So Mrs Brown's annuity brings in £6,681 a year and her loan costs her £1,89 6 a year.

The difference is the amount she has to spend:

Net annual income £6,989

Net weekly income £99.68

Mrs Brown took out her plan with an insurance company.

The rate of interest they charge on the loan is fixed at the current rate of 8.89 %. That rate will not change whatever happens to interest rates.

So she knows that her income from the plan will stay the same for the rest of her life. However, there are some schemes, mainly sold through building societies, that charge a variable rate of interest.

These rates are generally higher but the annuity you receive is also greater. However, if interest rates rise, the net income you have left can be drastically reduced and, in extreme cases, may disappear altogether.

Generally, a fixed rate gives you a slightly lower income but it is guaranteed for life. Variable rates give you a higher income initially, but it may vary and you run the risk of your income going down considerably.

Please remember this website is for informational purposes only and does not constitute professional financial advice.

- How Much Will You Get?

or The Value Of Your Home

How Much Will You Get?

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