By taking the lump sum option offered on most personal pension schemes you receive a tax-free lump sum and purchase an annuity with the balance.

Because the annuity is taxable whereas the lump sum is not (as long as it does not exceed 25% of the pension fund), you can be considerably better off from a tax viewpoint by taking the lump sum.

Example:

Upon retirement Alex is offered the choice of:
• a straightforward annuity for his pension fund of £100,000 of £6,000 per year, or
• a lump sum of £25,000 and an annuity of £5,000 per year.

By taking the latter lump sum option he saves tax yearly on the amount of the annuity forgone.

He also has the opportunity to invest the lump sum to generate additional income (although any income earned may be taxable in its own right depending on the nature of the investment).