From April 2027, the government will end the inheritance tax (IHT) exemption on pensions, meaning any unspent pension pots will be included in your estate for IHT purposes. However, experts have identified a loophole using annuities that could help families reduce the tax burden.
How the Annuity Loophole Works
Annuities allow you to take a lump sum from your pension and purchase an income for life. These can be structured to continue paying out to a beneficiary after your death, such as a spouse, partner, or even an adult child. The income received by the beneficiary is subject to income tax, not inheritance tax, effectively bypassing the IHT charge.
According to pension firm Standard Life, 39% of financial advisers expect annuities to become more popular as a result of the upcoming change. Interest in annuities had waned over the last decade, but the new rules could revive their appeal for savers looking to pass on pension wealth tax-efficiently.
Expert Opinions on Joint and Single-Life Annuities
Clare Moffat, a pensions expert at Royal London, said: “If you are not married but want your partner to get something when you die – without having to pay inheritance tax – a joint annuity could be a really good idea.” Married couples and civil partners can already pass assets IHT-free, but for those wanting to benefit other family members, annuities offer a solution.
Nick Flynn, from retirement specialists Canada Life, added: “There's no reason why you can't take out policies for each child. The children would need to be grown up – at least 35 – when the policies are taken out, otherwise they would cost a fortune. But it could also be a good option if you would rather hand over an income than a lump sum that you fear they might spend on a Ferrari.”
Considerations and Trade-Offs
It is important to note that the income from an annuity with a younger beneficiary will be significantly lower than one for yourself or a spouse of a similar age, because the policy is likely to pay out for decades longer. This trade-off must be weighed against the IHT savings.
The loophole is particularly attractive for older Brits with large pension pots who wish to leave a legacy to loved ones without triggering a 40% IHT charge. As the April 2027 deadline approaches, financial advisers anticipate a surge in annuity purchases driven by tax planning.
