Pensions IHT change could trigger ‘exodus of large DC pots’

There are growing signs that the Budget 2024 decision to include unspent pension pots in the scope of Inheritance Tax (IHT) is leading to larger pension pots being run down by those seeking to reduce potential IHT bills, according to LCP partner Steve Webb.

Under the change, due to be implemented in April 2027, the value of unspent DC pots (as well as certain DB death benefits such as ‘death in deferment’ lump sums) will be added to the value of the estate when IHT is worked out. The Government estimates that this will bring around 10,000 estates per year into IHT for the first time as well as increasing IHT bills for a further 40,000 estates.

But the long lead time has given financial advisers the opportunity to consider a range of strategies to mitigate the impact of the change, and this is most likely to be seen for larger pot sizes where the IHT risk is greatest. Two financial products which are already seeing increased market activity are:

• Annuities – where savers can convert some or all of their DC pot into a lifetime income stream, and potentially gift the annuity income using the “normal expenditure from income” exemption; provided that the rules are followed, these gifts can immediately be exempt from IHT. If a joint life annuity is bought, then this carries on after the death of the first person. This is IHT free for the second life, even if they aren’t married or in a civil partnership;
• ‘Whole of Life’ policies – savers can use income to pay for regular premiums for a policy which pays out a guaranteed lump sum when the saver dies; such payouts are free of IHT, provided the policy is set up under trust. Alternatively, this lump sum could pay for any IHT bill. In the case of a couple, the policy can be set up to pay out on the ‘second’ death, meaning that it pays out only at the point that the estates passes between generations, and this reduces the cost of the policy; this is known as a ‘joint life, second death’ policy, and typically applies for deaths up to age 90;

In both cases, the policies typically take account of the likely life expectancy of the consumer. In the case of an annuity, those in poorer health will generally get a better rate (as the annuity will pay out for a shorter period). But with a Whole of Life policy, terms will generally be better for those in good health (as the premiums will run for longer and the expected payout date will be later).

In terms of annuities, the Association of British Insurers (ABI) recently reported a surge in annuity purchases with larger pots. ABI reported that sales of annuities over £250,000 rose by 31% year-on-year in 2025, and sales of annuities valued at over £500,000 rose by 54%.

With regard to ‘Whole of Life’ policies, industry sources suggest a surge in demand, with an increase of 92% year on year reported in Spring 2025 (Protection sales surge as adviser confidence climbs).

Financial advisers will be able to recommend the right strategy for each individual, but factors which consumers are likely to consider include:

• Timing: with the annuity option, the pension saver is ‘giving while living’ – passing on regular income immediately to heirs, whereas a ‘whole of life’ policy delivers a lump sum on death;
• Health: as noted above, those in poor health could potentially get favourable annuity terms (though risk giving up their capital for a relatively limited payout period), whilst those in good health could get favourable terms from a ‘Whole of Life’ policy, especially one which only paid out on the ‘second death’ in a couple;
• Adjusting for inflation: whole of life premiums can be fixed in cash terms, providing assurance that the member can keep up the payments for life, or can be set to increase, thereby helping to maintain the real value of the eventual payout;

For both products, the saver will need to keep records so that their heirs can demonstrate ‘where the money went’ whilst the saver was alive, to ensure that HMRC do not attempt to add the money gifted (or spent on premiums) back into the estate after death.

Commenting, Steve Webb, partner at pension consultants LCP said: “For many years, one of the attractions of DC pensions has been their favourable treatment under Inheritance Tax rules, especially for those with larger pots. But the Budget 2024 announcement has changed things, and people with larger pots are now exploring a range of strategies to reduce any potential IHT bill for their heirs. DC pension providers can expect to see changing behaviour amongst savers with the largest pots, with more interest in drawing down more rapidly for gifting or purchase of a whole-of-life policy, or even using the whole pot for annuity purchase. Providers may find that the largest pots disappear the quickest post-retirement”.

Clare Moffat, Pensions and Tax Expert at Royal London said: “There is a wide range of options open to those looking to revise their post-retirement strategy in light of the forthcoming imposition of Inheritance Tax on pensions. It is clear that there is growing interest for clients who might be affected by IHT in financial products such as annuities or ‘Whole of Life’ policies. But the options are complex and it may be worth an inheritance tax bill if that makes family members better off. Most people would benefit from taking professional financial advice so they can work out the best course of action for their specific circumstances."