How Is Annuity Income Taxed in the UK?

A pension annuity turns your pension pot into a guaranteed income for life — but that income does not arrive free of tax. In most cases an annuity is taxed in exactly the same way as a salary or the State Pension: as ordinary income, at your marginal rate. This guide explains how UK annuity tax works in the 2026/27 tax year, why your first payment might look oddly small, and where the rules are more generous for annuities bought with non-pension savings.

The short answer: an annuity is taxed like earned income

When you buy an annuity with money from a pension — technically a "compulsory purchase annuity" — the whole of each payment is treated as pension income and taxed at your marginal rate of income tax. There is no separate, lower "annuity tax rate". If you are a basic-rate taxpayer you pay 20% on the taxable income; if your total income tips you into the higher-rate band, the slice above the threshold is taxed at 40%, and so on.

This is the same tax treatment that applies to income you take from pension drawdown. The difference between the two is not the tax — it is that an annuity pays a fixed, guaranteed income, whereas drawdown income can rise, fall or run out. For the taxman, both are simply income.

Your marginal rate in 2026/27

For someone living in England, Wales or Northern Ireland, the income tax bands for the 2026/27 tax year are:

• Personal Allowance — the first £12,570 of total income is tax-free
• Basic rate (20%) — income from £12,571 to £50,270
• Higher rate (40%) — income from £50,271 to £125,140
• Additional rate (45%) — income above £125,140

These thresholds are frozen and are not due to rise for several years, so as incomes creep upwards more retirees are gradually pulled into paying tax — an effect known as "fiscal drag". If you are a Scottish taxpayer, different bands and rates apply to your annuity income, including a 21% intermediate rate and higher rates at the top, so the figures above will not match your bill.

Importantly, it is your total income that decides the rate. Your annuity, your State Pension, any drawdown or earnings, and your taxable savings and dividends are all added together to work out which bands you fall into.

The State Pension uses up your allowance first

The State Pension is taxable, but it is always paid gross — with no tax taken off at source. In 2026/27 the full new State Pension is £241.30 a week, or roughly £12,548 a year, which sits just below the £12,570 Personal Allowance. That matters for annuity tax because the State Pension effectively fills up most of your tax-free allowance before your annuity is even counted. For many pensioners that means almost all of their annuity income is taxable, even though the allowance looks generous on paper.

Because tax cannot be deducted from the State Pension directly, HMRC usually collects what is due on it by adjusting the tax code applied to your annuity or other private pension income instead.

The 25% you take before you buy is tax-free

Before you buy an annuity you can normally take up to 25% of your pot as a tax-free lump sum — the pension commencement lump sum — capped for most people by the lump sum allowance of £268,275. Only the money left after that is used to buy the annuity, and only the annuity income that follows is taxable.

Some people take the full 25% in one go; others take it in stages. The order and timing can affect your overall tax position, which we unpack in our guide to taking your tax-free cash all at once versus in phases.

How the tax is actually collected: PAYE

Your annuity provider operates PAYE, deducting income tax before the money reaches your bank account using a tax code issued by HMRC. Once the correct code is in place, the right amount should come off each month and most annuitants never need to complete a tax return.

The complication is the very first payment. If HMRC has not yet issued a code, the provider may apply an emergency tax code, which can over-deduct in the early months. The system normally corrects itself once your proper code catches up, and any overpayment can be reclaimed. Our article on emergency tax on pension withdrawals explains how to claim it back.

Purchased life annuities are taxed more kindly

Not every annuity is bought with pension money. If you buy an annuity using ordinary savings — say, from an inheritance or the sale of a property — it is a "purchased life annuity", and the tax treatment is more favourable.

HMRC treats each payment as partly a return of your own capital and partly interest. The capital element is tax-free, because it is simply your own money coming back to you; only the interest element is taxed, and it is treated as savings income. The provider works out the split based on your life expectancy when you buy. The practical effect is that a purchased life annuity can leave you with more income after tax than a pension annuity paying the same headline amount — although you are funding it with money on which you have already paid tax.

Tax on annuity death benefits

Annuities can carry on paying out after you die if you add options such as a guarantee period, value protection or a joint-life basis. Whether those payments are taxable in your beneficiary's hands generally depends on how old you are when you die:

• If you die before age 75, continuing annuity income and value-protection lump sums are usually paid tax-free (a lump sum normally has to be settled within two years).
• If you die at 75 or older, your beneficiary pays income tax at their own marginal rate on whatever they receive.

Separately, from 6 April 2027 most unused pension funds and death benefits are due to be brought within your estate for inheritance tax. We look at what that means in the 2027 pension inheritance tax changes, and at how the options themselves work in what happens to your annuity when you die.

The bottom line

For most people, a pension annuity is taxed just like any other income: your provider deducts tax under PAYE at your marginal rate, and how much you pay depends on your total income for the year rather than on the annuity alone. Purchased life annuities are the main exception, and death benefits follow their own before-and-after-75 rules. Understanding which slice of your income is taxable — and at what rate — helps you compare an annuity against drawdown on a genuine like-for-like, after-tax basis.

Weighing up a guaranteed annuity against keeping your pension invested? Compare your options with our annuity and drawdown comparison, model your future income and tax using the retirement planner, or get in touch to speak with a regulated adviser.