This annuity is bought with at least two-thirds of their accumulated capital in the fund. They then have the option of what is called a compulsory annuity or a living annuity.

Each of these annuities provides an income and the income is made up of interest income and a return of capital. In both cases, though, the whole of the annuity is regarded as income for tax purposes.

The advantage of the living annuity option is that it offers greater flexibility than the compulsory annuity - the annuitant may draw between 5% and 20% of the capital amount each year and may select and vary the investments. But the living annuity offers no tax advantage.

The other kind of annuity is voluntary. Investors use capital not derived from a pension fund to buy it, and payments are split for income tax purposes into the interest element and the capital element. The capital element is regarded as a repayment of capital and is not subject to income tax. The interest element is.

This explanation says nothing about the impact of capital gains tax (CGT) but the principle underlying the new tax suggests that capital gains will be taxed. It will be interesting to see how this will work in practice.

Fortunately, CGT will be levied at a lower rate than personal income tax, and only on capital gains, not on the basic capital element. But losses cannot be offset against gains. And the mechanics of calculating monthly or even annual capital gains and losses on an investment that repays capital at a regular rate must be daunting.

People who receive living annuities can argue that these receipts exclude capital growth. The capital growth is being left invested and only when the original capital invested is repaid will there be an "event" in the form of a withdrawal that will trigger CGT.