Annuities and Tax-Free Cash: Why More Income Isn’t Always the Best Fit

If you’re approaching retirement, taking your tax-free pension cash can feel like an obvious decision. Equally, the prospect of securing an income for life can be reassuring.

But these decisions are connected. Every pound taken as tax-free cash is a pound that will not be used to buy that guaranteed income.

So how do you decide?

In my latest video, I compare two approaches for the same person, with the same starting money and the same spending plans. The results show why the largest annual income does not necessarily deliver the retirement someone wants.

Meet Tammy: £800,000 in her pension, retiring at 57

Tammy is an illustrative example. She is single, aged 57, and has an £800,000 pension alongside £100,000 in savings and investments.

In the first option, she uses her entire pension to buy an annuity paying approximately £58,000 a year before tax. She keeps her existing £100,000 outside it.

In the second, she takes £200,000 tax-free and uses the remaining £600,000 to buy an annuity paying approximately £43,400 a year before tax. She now has £300,000 outside the annuity.

Both options start with £900,000. Taking tax-free cash does not create extra money; it changes how much remains accessible.

These are the illustrative annuity figures used in the video, not current quotes. Both annuities are single-life, level policies with no guarantee period. The income stays the same in pounds and does not rise with inflation.

What does Tammy want her retirement to look like?

Tammy wants to spend more while she is younger: travelling, enjoying experiences and making the most of her active years.

The model uses spending of £60,000 a year through age 69, £40,000 a year in her seventies and £30,000 a year from age 80, expressed in today’s money.

This is a deliberately chosen example to demonstrate the effect of spending more early in retirement. It is not a suggested budget or a prediction of how everyone’s spending will change.

The projection runs to age 95. It assumes 2% inflation, steady annual growth of 5% on investments and 2% on cash, and the full new State Pension from age 67. It uses the tax assumptions in the recording script.

Why the bigger annuity falls short

An income of £58,000 sounds substantial. But it is taxable, so Tammy has less than that available to spend.

Her planned spending starts at £60,000 and rises with inflation. She therefore needs to draw on her £100,000 of accessible savings to make up the difference.

In this illustration, those savings are exhausted at around age 64.

Her annuity has not run out. It continues paying for life. The problem is that it cannot fully support her planned spending, and she has no accessible reserve left to bridge the gap.

Later, when her spending falls and her State Pension is in payment, the balance improves. However, a surplus later in retirement cannot fund an earlier shortfall without another source of money.

What changes when she takes tax-free cash?

With the smaller annuity, Tammy receives less guaranteed income but has £300,000 available outside it.

Under the model’s assumptions, that reserve allows her to top up her income throughout the higher-spending years without exhausting her accessible money.

Her remaining savings and investments reach a low of approximately £70,000 around age 70.

The difference is the timing and flexibility of the money available to her.

Tax also affects the comparison

Pension annuity income is taxable. Taking eligible tax-free cash first gives Tammy capital she can spend without that capital itself becoming taxable income.

However, interest, dividends and investment gains generated afterwards may be taxable, depending on where the money is held and her available allowances. Taking money out also removes it from the pension’s tax shelter.

The video’s model shows approximately £150,000 less cumulative tax by age 95 under the tax-free-cash option. That is an illustrative result over the full projection, not an immediate saving or an outcome everyone can expect.

A lower tax bill alone does not make a retirement plan better. The question is whether it supports the spending required, with risks the person can accept.

The catch: flexibility comes with responsibility

Tammy is spending her own capital to supplement the smaller annuity. Those withdrawals are not extra guaranteed income.

The model also assumes smooth investment growth every year. Real markets fluctuate. Poor returns early in retirement, higher inflation or unexpected spending could leave the flexible option running short too.

Her spending may not fall as planned. Care costs or family commitments could change the picture.

A larger annuity may appeal more to someone who prioritises predictable income, wants less to manage or worries about overspending accessible savings. A level annuity still carries inflation risk: the payment stays the same while its purchasing power can fall.

It does not have to be all or nothing

One approach to explore is securing enough guaranteed income to help cover essential bills while retaining money for flexibility.

The annuity’s features matter too. Rising income, a partner’s pension, a guarantee period or value protection can change both the starting income and what happens after death. Health and lifestyle information may also affect the rate offered.

Once the cooling-off period ends, an annuity generally cannot be undone. Comparing the options before committing matters.

The question to ask is not simply, “How much income can I get?”

It is, “Will my money be available when I actually need it?”

🎥 Watch the full comparison and see Tammy’s retirement projections.

📋 Download our free Retirement Checklist to help you work through the decisions ahead.

📞 If you would like help exploring your retirement options, book a free, no-obligation 15-minute initial call with our team.

General information for UK residents, not personal financial advice. Figures are illustrations from the recording script dated 21 October 2026. Projections depend on assumptions; actual investment returns, inflation, tax and spending may differ. Investments can fall as well as rise, and tax treatment depends on individual circumstances. Rules and annuity rates can change.

Clarity Wealth Limited is authorised and regulated by the Financial Conduct Authority. FCA reference number: 758444.