When you retire you will normally have accumulated a pension fund which is designed to purchase a monthly income for the rest of your life, this is usually where an Annuity is purchased.
Alternatively, these funds can be used to purchase a form of unsecured pension income (commonly referred to as income drawdown) where the purchase of an annuity is delayed.
In this instance, the retiree risks what is referred to as mortality drag whereby income taken diminishes the amount that can be used to buy an annuity.
If an annuity is purchased, the income is taxable. Retirees have the option of taking 25% from their accumulated pension funds as a tax free lump sum or Pension Commencement Lump Sum.
The 25% that can be withdrawn as tax free cash can be used to buy a Purchased Life Annuity which is a voluntary purchase made by the investors own free will.
As such the income from a purchased life annuity is split in the eyes of HMRC into return of capital and interest. Return of capital is not taxed and since this makes up the bulk of the income payable, this makes income from Purchased Life Annuities much more beneficial to retirees who expect to be tax payers into retirement.