Finding annuity purpose

Data from the Association of British Insurers (ABI) shows that annuity sales increased by 24% for the year to 2024 to record sales of £7 billion. For context, the years 2015 to 2022 were in the region of £4 billion each year while 2023 exceeded £5 billion.

This increase is probably not that surprising. We have had rising interest rates and, maybe to a less extent, some fears around the future market conditions. Interestingly though, this same data set shows that annuity purchases by 36% of buyers in 2024 were those who bought their annuity after taking advice, a notable increase from the 29% that did so in 2023. This shows us more advisers are looking at annuities which perhaps was not the case.

We would expect this 36% to increase over the next year too, now that we have the threat of IHT hanging over drawdown. In this context it is worth looking at how annuities shape up in the world where pensions are subject to IHT.

We know from the legislative plans (which are of course subject to change) that almost all forms of defined contribution pensions are within the scope of IHT. Combined with exceeding the LSDBA or being subject to beneficiary tax after age 75, there is potential for relatively large tax bills for some.

How do annuity death benefits compare?

The main death benefit by far is a spouse/dependent pension. If the annuitant dies before the age of 75, the income is tax-free for the spouse/dependent. After 75, it’s is taxable as earned income.

This option is completely outside the scope of IHT for both the original annuitant and the beneficiary. This means the only type of tax paid here is personal rates of income tax by the recipient.

Guarantee Period

The structure of a guarantee period, when included in an annuity, usually takes the form of an ongoing income payment made by the insurer to the next of kin/estate of the annuitant for the amount of time selected (anywhere from 1-30 years typically).

The income from a guarantee period is similar to the spouse/dependent pension in terms of being tax-free before 75, but taxable if death is after 75.

In terms of IHT, the guaranteed income is outside the estate only if the direction of this benefit is ‘subject to the discretion of the provider’. Essentially this means as long as the annuitant is not mandating how the benefit is paid, it is free of IHT. This is similar to how, under current legislation, pension death benefits are outside the estate when not subject to a binding nomination.

Value Protection

The alternative to a guarantee period is to protect the lump sum used to purchase the annuity. A value of between 0% and 100% can be protected and each annuity income payment reduces the amount that could be paid out.

Like the other death benefits covered, this is tax-free / taxable depending on if death falls before or after age 75.

The full lump sum paid out is however considered part of the estate for IHT purposes, regardless of where it is paid and under whose discretion.

Death benefits overview

The overview of the above is as follows:

 

	Death before 75		Death after 75
	IHT	Income Tax	IHT	Income Tax
Drawdown	Yes	No	Yes	Yes
Annuity – Spouse Pension	No	No	No	Yes
Annuity – Guarantee Period	No*	No	No*	Yes
Annuity – Value Protection	Yes	No	Yes	Yes

*Assuming no binding direction is setup by the annuitant

From a strictly tax perspective, the guarantee period seems to be the most effective way of avoiding IHT. A 15-year guarantee will completely cover annuities over 6.66% while a 30-year guarantee will cover annuity rates over 3.33%.

So, what are the disadvantages of buying an annuity with a long guarantee period to mitigate IHT? Well, opportunity cost and tax are two main ones.

Opportunity cost in that the potential of 10, 20 or 30 years of investment return on an uncrystallised/drawdown pot could lead to a higher net value (even after a 40% tax charge) compared to avoiding IHT by using a guarantee period.

Purchasing an annuity will also likely involve tax paid on each income payment. The cumulative effect of this over time could outweigh any IHT saving made. Purchasing an annuity will also involve a loss of flexibility to respond to changes in taxation and/or legislation, and a commitment to a specific annuity at the outset.

Conclusion

Death benefits are going to be more important as we move toward April 2027 and knowing how certain annuities sit in this regard, to compare against the uncrystallised/drawdown pension, is key to ensuring the right decisions are made for clients.

For more information or support with any technical queries, contact the Verve team at hello@weareverve.co.uk

Grant Callaghan, Financial Planning Specialist, We Are Verve