Should you buy an annuity ahead of the new Inheritance Tax rules?
With unused pensions facing Inheritance Tax from April 2027, many retirees are turning to annuities. Learn the pros, cons and alternatives before you decide.
How you decide to withdraw from your defined contribution (DC) pension – an invested fund built up by regular contributions – might be one of the most important decisions in your retirement plan.
Typically, there are several options you can choose from:
- Lump sum – withdraw up to 25% of your pension pot tax-free up to the Lump Sum Allowance (LSA) of £268,275 and pay Income Tax at your marginal rate on the remaining 75%.
- Flexi-access drawdown – keep your pension pot invested and take money out as and when you need it (spreading your 25% tax-free entitlement across your withdrawals).
- Buy an annuity – exchange all or part of your pension for a guaranteed regular income for a fixed period of time or for life.
- A combination – mix and match the above retirement income options.
While there is no “right way” to withdraw from your pension, there has been a recent increase in the number of retirees exchanging their DC pension for an annuity – sales reached £7.4 billion in 2025, up 4% from the year before, the Guardian reports.
Alongside greater security and peace of mind for retirees, annuities are being used to pre-emptively mitigate new Inheritance Tax (IHT) rules, which will see unused pension pots included in your estate when you die (more on this later).
However, the current popularity of annuities doesn’t necessarily mean they’re the right option for your financial plan, even when the IHT rules change in April 2027.
Keep reading to find out why.
Annuities are being used to reduce the effects of more stringent Inheritance Tax rules coming into effect from April 2027
At the time of writing, pension schemes fall outside of the remit for IHT, meaning you could leave a large pension pot to your loved ones when you pass away without them paying IHT on the sum.
However, from 6 April 2027, most unused pension funds and pension death benefits will be included within the estate for IHT purposes. This may increase your estate’s IHT liability if its value, when combined with your other assets, exceeds certain thresholds:
- The nil-rate band is currently frozen at £325,000 until 2031.
- The residence nil-rate band is currently frozen at £175,000 until 2031. This only applies if you are passing on your main residence to a direct descendant.
Many UK savers are rethinking how they might pass on IHT-efficient wealth from the next tax year, and some have turned to annuities for the answer.
For example, if you purchase a standard lifetime annuity at any point in retirement, this exchanges the value of your pension pot for a guaranteed, regular income for the rest of your life. Effectively, this removes money from your estate and could help bring down your IHT bill.
Annuities can be helpful, but there are downsides – here are 3 benefits you could lose
The decision to buy an annuity is typically irrevocable. If you’re on the fence about making the change, here are some key benefits that you might miss out on once you purchase an annuity.
- Flexibility
As mentioned, annuities convert your pension capital into a guaranteed, regular income stream.
This is good for stability, but not so much for flexibility – an annuity usually pays out a fixed amount each month, whereas you retain flexible access to your wealth in a DC pension pot.
While regular fixed payments can help you avoid overspending, it can be difficult to handle expensive one-off costs like a home renovation, an extended holiday, or an emergency. On the other hand, having access to your pension pot provides you with the ability to withdraw as much as you need when you need it.
- Continued investment growth
A key benefit of annuities is their enhanced security for your retirement income.
Wealth from a DC pension fund is finite and can rise and fall in value due to market performance. Conversely, an annuity provides guaranteed income either for a fixed term or for life. This can give you peace of mind knowing you won’t run out of money in retirement.
However, there is a caveat to this added security – while annuities protect against your invested pension falling in value, it also means you won’t be able to benefit from investment growth.
Moreover, keeping your pension invested could increase the longevity of your retirement wealth or the size of the inheritance you wish to leave behind for your loved ones.
- Outpacing inflation
Inflation erodes the value of your wealth over time. Furthermore, if you are on a fixed income from an annuity, the effects can be even more stark as the value of your income gradually loses its purchasing power.
DC pension funds, on the other hand, remain invested and have the opportunity to continue growing and outpace inflation. However, know that this is not a guarantee, and past performance is not an indicator of future results.
You can purchase index-linked annuities, which ensure that your payments will rise in line with inflation. However, they are typically more expensive than fixed annuities.
A Kellands financial planner can help you find alternative ways to lower your estate’s IHT liability
From April 2027, unused pension pots will stop being a viable strategy to help you reduce your estate’s IHT liability.
However, that doesn’t mean that you can’t seek out alternative routes to help you reclaim your estate’s IHT efficiency, such as:
- Gifting from surplus income
- Lifetime gifting
- Using your annual exemption
- Holding wealth in trusts.
You can learn more about these various options by reading articles on our website:
- ‘The ultimate balancing act: Gifting versus saving’
- ‘Giving while living: 3 reasons to slow down and make a plan’
- ‘Do you have an Inheritance Tax strategy that works for your family?’
- ‘Half of young people are putting plans on hold due to the high cost of living’
- ‘The Great Wealth Transfer’
If you’re concerned about the new pension rules and considering significant changes to your retirement plans, speak to one of our award-winning financial planners today.
We can help reassure you about your plan and whether any changes are necessary, as well as tailor bespoke strategies to help you mitigate your estate’s IHT liability outside of traditional pension routes.
Or, if an annuity is right for you, we can help you select the product that best suits your circumstances so that you can live out retirement with financial peace of mind.
Email us at hale@kelland.co.uk, or call 0161 929 8838.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.
The Financial Conduct Authority does not regulate estate planning or tax planning.