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Should you buy an annuity to reduce inheritance tax?

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UKPublished 6 October 2026 · Written by BuyMeWhiskey Editorial Team · How we check facts

Buying an annuity can change how your wealth is held, but it is not a simple inheritance-tax saving. From 6 April 2027, most unused pension funds will enter the estate for Inheritance Tax, while continuing annuity payments are excluded. The retirement-income trade-off still matters.

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What an annuity actually does

An annuity uses some or all of a defined contribution pension to buy a guaranteed income. A lifetime annuity normally pays for the rest of your life; a fixed-term annuity pays for an agreed period. MoneyHelper recommends comparing the market rather than automatically accepting the quote from an existing provider.

The price of the guarantee depends on the size of the pension used, your age and health, the way the income rises, whether it continues to another person after your death, and market conditions. A medical condition can sometimes produce a higher quote because the insurer expects a shorter payment period.

Why the inheritance-tax answer changes in 2027

For deaths on or after 6 April 2027, most unused pension funds and pension death benefits will be brought within the value of the estate for Inheritance Tax purposes. HMRC's 2026 technical note explains that the reform is legislated through Finance Act 2026 and is due to apply from that date.

That means the old idea that leaving money inside a pension automatically keeps it outside the IHT calculation no longer works in the same way. The reform is specifically about unused pension property on death. It does not mean every pound ever paid into a pension becomes immediately taxable.

Why continuing annuities are different

HMRC's published rules say the new pension-IHT regime does not apply to continuing annuities. That is a meaningful distinction. Once a lifetime annuity is already in payment, the continuing income is not treated like an unused pension fund waiting to be inherited.

That still does not make “buy an annuity for IHT” a universal strategy. Buying the annuity is an exchange: you give up pension capital and receive a stream of income. The income is taxable as pension income in the normal way. If you spend it, the capital may no longer exist to pass on. If you save it in a bank account or investment account, those assets can form part of your estate just like other assets.

Why it is not a free tax saving

Suppose someone has a large defined contribution pension and buys an annuity. They may reduce the amount left in the pension because some of the money has been used to buy the annuity. That does not by itself mean the family's overall wealth is reduced by the same amount for IHT purposes: the person may also receive an income which is spent, gifted, invested elsewhere, or used to support a spouse.

There is also an opportunity-cost question. Once an annuity has been purchased and the relevant cooling-off period has ended, MoneyHelper says you typically cannot change your mind. A person who later discovers that they wanted more flexible withdrawals cannot simply reverse the purchase.

The annuity features matter more than the label

Lifetime or fixed-term: a lifetime annuity is designed to last for life; a fixed-term product ends on a specified date.
Level or increasing income: an increasing annuity can help with inflation risk but usually starts lower than a level income.
Single life or joint life: some products continue income to a spouse or civil partner after death.
Guarantee period: a guarantee can protect payments for a minimum period, subject to the contract terms.
Enhanced annuity: health and lifestyle information may lead to a higher income quote in some cases.

Tax and the tax-free lump sum

For 2026/27, the standard individual Lump Sum Allowance is £268,275. You can usually take up to 25% of a pension as tax-free cash, subject to the allowance and any protection you have. MoneyHelper notes that you do not have to take the full 25% before buying an annuity.

Income from a lifetime annuity is pension income and is normally taxed through PAYE. The taxable amount counts with your other taxable income when working out Income Tax. Taking a large lump sum or a larger annuity income can therefore affect your tax position even when the product itself is designed to be straightforward.

Shop around before deciding

MoneyHelper's annuity guidance recommends comparing providers, including your existing provider. FCA historical review work also found that some customers did not shop around even when a better rate might have been available. Your quote is personal, so comparison needs to use the same pot, same income pattern, same escalation option and same death-benefit choices.

For an IHT question, also separate two decisions: how to fund retirement income and how to pass wealth on death. The right answer may involve a mixture of annuity income, flexible pension withdrawals, cash savings and other investments rather than forcing one product to solve both problems.

Worked example

Illustrative example: suppose a person has a £100,000 defined contribution pension and is comparing two hypothetical lifetime annuity quotes. These are illustrative rates, not a current market quotation.

Quote A at 5% would pay £100,000 × 0.05 = £5,000 a year.
Quote B at 4.5% would pay £100,000 × 0.045 = £4,500 a year.
The difference is £5,000 − £4,500 = £500 a year.

Now add the IHT question. If the annuity is already continuing when the member dies, HMRC's published rules exclude continuing annuities from the new pension-IHT regime. But the £5,000 or £4,500 income received during life is taxable pension income, and any part that is saved can build up elsewhere. The example shows why the annuity decision should be tested on income security, death benefits, flexibility and estate planning together rather than on IHT alone.

Can an annuity reduce my Inheritance Tax bill?#

Not automatically. An annuity changes a pension pot into a stream of income, and continuing annuities are excluded from the new pension-IHT rules from 6 April 2027. But the income you receive can be spent or saved elsewhere, and saved money can still form part of your estate. The tax result therefore depends on the whole balance sheet.

Are pensions still outside Inheritance Tax in 2026?#

For the 2026/27 tax year, most unused pension funds are still outside the estate under the existing rules, but the law changes for deaths on or after 6 April 2027. HMRC has legislated to bring most unused pension funds and pension death benefits into the estate for IHT purposes. Planning should therefore consider the date of death rule, not just today’s treatment.

Will a lifetime annuity be subject to Inheritance Tax?#

A continuing annuity is specifically excluded from the new pension-IHT measure. That does not mean every payment is tax-free: annuity income is normally taxable as pension income. The important distinction is between an annuity that is already continuing and unused pension funds remaining in a pension arrangement at death.

Should I buy an annuity before the pension IHT changes?#

There is no general rule that buying an annuity before the change is the right move. The annuity removes flexibility and converts capital into guaranteed income, so you should compare the retirement-income value with the estate-planning effect. The date of purchase, pension type, death benefits, health and whether income will be spent all matter.

Can I leave an annuity to my spouse?#

Some annuities can continue paying income to a spouse or civil partner after your death, while others stop when the original annuitant dies. Options such as joint-life cover and guarantee periods usually affect the quote. Check the contract rather than assuming an annuity automatically leaves a pot of capital for beneficiaries.

Is annuity income taxed in the UK?#

Yes. HMRC treats income from a lifetime annuity as pension income. The annuity provider normally operates PAYE on the taxable payments, and the income counts alongside other taxable income when your tax position is worked out. Taking tax-free cash first can also change the amount of pension capital left to buy the annuity.

Should I shop around for an annuity?#

Yes. MoneyHelper says you should compare providers, including your existing pension provider. Annuity quotes can differ because providers price health, age and the features you choose differently. Compare like with like, including whether income rises, whether a spouse receives anything, guarantee periods and the amount of pension being exchanged for the annuity.

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Next question →How much can you put into a 401(k) after tax in 2026?

Sources

Figures were checked against these sources before publication. If a rule changes, we update the page and show the new date.

General information, not personal financial advice. Rules depend on your circumstances; check the official source or speak to a regulated adviser before acting.