I am 67 and after combining two SIPPS I now have a single SIPP worth approximately £500,000. 

I drew income flexibly in the past from one of the SIPPs. My understanding is that I can take 25% tax free from my SIPP at any point and then the remaining pot is taxed on withdrawal at marginal rates. 

I could use some or all of the remaining amount in the SIPP to purchase an annuity, so my question is on the taxation of annuities purchased, and whether this is different depending on whether the funds used to purchase the annuity have had 25% tax free allowance already taken?

Simon

Rachel Vahey, AJ Bell Head of Public Policy, says:

One of the benefits of pensions is the flexibility to take as much money as you want and when you want from the plan.

If you are 55 or over (rising to 57 from April 2028) you can access the money in your SIPP. You don’t have to take it all at once; if you want you can access a bit at a time. You then have a range of options about how you can take the pension pot.

You can take your tax-free cash, which is usually 25% of the pension pot, and use the remainder to buy an annuity, which is a guaranteed income for life. Or you could move the remainder to drawdown and then take an income either regularly or on an ad-hoc basis. Alternatively, you could take the whole 75% as a taxed lump sum.

When you do take the income from the money accessed (the remaining 75%) – whether that’s an income from drawdown, an annuity instalment or as a lump sum – it is taxed as income at your marginal rate. It’s easy to see how taking a larger amount of income can push up your total income and may mean part or all of it is taxed at a higher rate of tax.

Buying an annuity means exchanging a lump sum with an insurance company for the guarantee that an income will be paid to you until you die. Most annuities are bought on the basis that they are only ever paid to the person buying them and stay the same level each instalment. However, you can choose for them to increase each year – in line with inflation or at a fixed rate. Or you can opt for them to continue to your partner when you die, probably at a lower rate, say 50%.

Picking either or both of those options will reduce the starting amount of income you could receive. So, you will need to work out if it’s worth it for you.

OPTING NOT TO TAKE TAX-FREE CASH

You could increase the amount of income you could receive by choosing not to take any tax-free cash, as the lump sum being used to buy the annuity will be that much larger. But each income payment would still be taxed at your marginal rate, and you would lose the right to receive any tax-free cash from those funds.

The starting income offered to you by an insurance company will also depend upon your health conditions, and most annuity providers will ask for some medical information upfront so they can work out the best rate to offer you.

After annuity rates being in the doldrums for the 2010s, they have recently increased, in part because gilt yields are rising. And the recent gilt yield resurgence should filter through to improved annuity returns. This may mean they become a more attractive option for some.

When deciding whether to go down the drawdown or annuity route it’s important to remember that they have very different strengths and weaknesses.

Broadly, annuities are guaranteed, so regardless of what happens in the economy or what changes government make, they will keep on paying out to you. They are also a hands-off choice; you have no further decisions or role in managing them. You can choose to bolt on some return of cash for when you die, but mostly annuities stop when you die (or when your partner dies).

THE MORE FLEXIBLE OPTION

Drawdown is more flexible allowing you to change the amount you take each time, so if your circumstances change you can adjust. Your fund remains invested, so you have the opportunity to benefit from long-term growth. And the death benefits are extremely attractive. Currently, if you die before age 75, usually any remaining fund can be returned to your family tax free. If you die aged 75 or over, they will have to pay income tax when they take out the money. 

From April 2027, the government plans to bring pensions, including unused drawdown pots, into the scope of inheritance tax (IHT). However, this is not yet confirmed, and we do not yet know exactly how this will work in practice.

Finally, this doesn’t have to be a binary choice. You can choose to use part of your pension to buy an annuity, part of it to take drawdown, and part to take wholly as a taxed lump sum. The choice is yours.

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