Annuity or drawdown: the tax differences

Q: How does the tax free lump sum work with each?

Drawdown. When you designate funds into flexi access drawdown you can take a tax free pension commencement lump sum equal to one third of the amount designated. HMRC's example in PTM062730 is a £40,000 pot: designate £30,000 and take £10,000 tax free. Annuity. Where a lifetime annuity is bought from uncrystallised funds, a lump sum paid in connection with the purchase can be a pension commencement lump sum, even if paid in the six months before the purchase (PTM062400). An annuity bought from a drawdown fund does not create a new entitlement, because the lump sum was available when the funds were designated. Either way, the total is capped by the lump sum allowance, £268,275 for 2026 to 2027 unless you hold a protected allowance.

Q: What happens on death?

GOV.UK's table on inherited pensions shows: Owner died under 75: payments from an annuity or from a drawdown fund set up or converted and first accessed from 6 April 2015 are usually tax free for the beneficiary. Owner died at 75 or over: annuity and drawdown payments to beneficiaries have Income Tax deducted by the provider. For an annuity, what is left to pass on depends on the options chosen. PTM062400 explains that a lifetime annuity can include a guaranteed period of any length, annuity protection or a dependant's annuity. A single life annuity without those options simply stops on death. Money still in drawdown remains available to beneficiaries. For Inheritance Tax, most unused pension funds and death benefits will be brought into the estate for deaths on or after 6 April 2027, with the spouse or civil partner and charity exemptions maintained. Funds left in drawdown are therefore potentially within the estate, whereas annuity income already paid out has left the pension. See pensions and Inheritance Tax.

Income from a lifetime annuity and income from flexi access drawdown are both pension income, taxed at your marginal rate through PAYE, and both can come with a tax free lump sum. The tax differences lie elsewhere: drawdown lets you choose how much taxable income to take each year, but the first drawdown payment triggers the £10,000 money purchase annual allowance, while a lifetime annuity that cannot go down does not. The two also differ on death, and from 6 April 2027 for Inheritance Tax.

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How is annuity income taxed?

HMRC’s Pensions Tax Manual at PTM062400 says income paid from a lifetime annuity contract to a member is taxable as pension income through PAYE, under sections 579A to 579D of the Income Tax (Earnings and Pensions) Act 2003. The insurer deducts tax before paying. The taxable amount for a tax year is the full annuity that accrues in that year under the contract, whenever it is actually paid.

All of the annuity is taxable. That differs from a purchased life annuity bought with your own money outside a pension, where part of each payment is a tax free capital element; see purchased life annuities.

How is drawdown income taxed?

PTM062730 explains that flexi access drawdown pension, which covers both income withdrawal and short term annuities, is chargeable to income tax as pension income under section 579A. You are taxed at your marginal rate on whatever you take in the tax year, and the scheme deducts tax through PAYE. You can take as much or as little as you like each year.

The first withdrawal is often over taxed because the provider has to use an emergency code. Our page on emergency tax on pension withdrawals explains how to reclaim it, and flexi access drawdown covers the wider rules.

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How does the tax free lump sum work with each?

Drawdown. When you designate funds into flexi access drawdown you can take a tax free pension commencement lump sum equal to one third of the amount designated. HMRC’s example in PTM062730 is a £40,000 pot: designate £30,000 and take £10,000 tax free.
Annuity. Where a lifetime annuity is bought from uncrystallised funds, a lump sum paid in connection with the purchase can be a pension commencement lump sum, even if paid in the six months before the purchase (PTM062400). An annuity bought from a drawdown fund does not create a new entitlement, because the lump sum was available when the funds were designated.

Either way, the total is capped by the lump sum allowance, £268,275 for 2026 to 2027 unless you hold a protected allowance.

Which triggers the money purchase annual allowance?

This is often the deciding tax point for anyone still paying into a pension. Once triggered, the money purchase annual allowance of £10,000 for 2026 to 2027 applies for that tax year and every later year.

Event	Triggers the MPAA?
Taking the tax free lump sum and designating into drawdown	No (PTM056530)
First income payment or short term annuity from a flexi access drawdown fund	Yes (PTM056520)
Lifetime annuity that cannot decrease, except in prescribed circumstances	No (PTM056530)
Lifetime annuity whose terms allow decreases, first entitled on or after 6 April 2015	Yes (PTM056520)
Staying within the cap in a capped drawdown fund set up before 6 April 2015	No (PTM056530)

Since 6 April 2015, a lifetime annuity can be set up to decrease in any way the contract allows (PTM062400). Products marketed as flexible or investment linked annuities may fall on the wrong side of this line, so check the contract terms before buying if you plan to keep contributing. See the money purchase annual allowance for how the test works.

Which gives more control over the tax bill?

Drawdown, because you choose the timing. For 2026 to 2027 the personal allowance is £12,570, basic rate applies up to £50,270, higher rate up to £125,140 and additional rate above that (rates outside Scotland). The personal allowance is withdrawn at £1 for every £2 of adjusted net income above £100,000. With drawdown you can take just enough each year to stay within a band, take more in a year when other income is low, or take nothing at all. An annuity pays a fixed amount whether or not you need it in that year.

The flip side is that drawdown makes it easy to take too much at once. A large withdrawal is taxed entirely in the year it is paid, so emptying a pot in one go can push income into higher rate or into the personal allowance taper.

What happens on death?

GOV.UK’s table on inherited pensions shows:

Owner died under 75: payments from an annuity or from a drawdown fund set up or converted and first accessed from 6 April 2015 are usually tax free for the beneficiary.
Owner died at 75 or over: annuity and drawdown payments to beneficiaries have Income Tax deducted by the provider.

For an annuity, what is left to pass on depends on the options chosen. PTM062400 explains that a lifetime annuity can include a guaranteed period of any length, annuity protection or a dependant’s annuity. A single life annuity without those options simply stops on death. Money still in drawdown remains available to beneficiaries.

For Inheritance Tax, most unused pension funds and death benefits will be brought into the estate for deaths on or after 6 April 2027, with the spouse or civil partner and charity exemptions maintained. Funds left in drawdown are therefore potentially within the estate, whereas annuity income already paid out has left the pension. See pensions and Inheritance Tax.

A worked illustration

Illustration only. Jo is 60, earns £20,000 a year part time and pays £12,000 a year into a workplace money purchase scheme. She has a separate personal pension of £100,000.

She designates £75,000 into drawdown and takes £25,000 tax free. Nothing else happens for tax yet, and her £12,000 contributions are unaffected.
If she then takes £5,000 of drawdown income, that payment is taxed at 20% (£1,000), but it also triggers the money purchase annual allowance. From then on her £12,000 a year of contributions is £2,000 over the £10,000 limit, and the excess is taxed through an annual allowance charge.
If instead she uses the £75,000 to buy a level lifetime annuity, the income is taxed at 20% in the same way, but the money purchase annual allowance is not triggered and her contributions can continue.

Common mistakes

Assuming annuity income is partly tax free, as a purchased life annuity is.
Taking a small drawdown payment “to test it” while still contributing, and triggering the money purchase annual allowance for good.
Buying an annuity that can decrease and not realising it counts as flexible access.
Comparing the options on income tax alone and ignoring the death benefit and Inheritance Tax position from 6 April 2027.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.