As a rule change is imminent, pensioners are "running down larger pots" to avoid inheritance tax

An "exodus of large defined contribution pension pots" could result from changes to inheritance tax (IHT) regulations for unused pension pots starting in April 2027, as retirees choose to spend their savings rather than leave their loved ones with an IHT bill

In an effort to lower potential inheritance tax (IHT) obligations, there is mounting evidence that pensioners with larger defined contribution pension pots are beginning to use them up completely or run them down much more quickly.

Unspent defined contribution pension pots will be added to the estate value when inheritance tax is calculated starting in April 2027. Similarly, some defined benefit death benefits, like lump sum death in deferment benefits. The 2024 Budget made the announcements.

According to government estimates, the change will increase IHT bills for an additional 40,000 estates and force approximately 10,000 estates annually to pay inheritance tax for the first time.

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Start your trial, but wealthy pension savers and their financial advisors have had time to implement a variety of strategies to mitigate the impact of the change due to the length of time between its announcement and its implementation.

Larger pot sizes, where the inheritance tax risk is highest, are most likely to have this effect.

Steve Webb, a former pensions minister and partner at pension consultants LCP, stated: "Defined contribution pensions have long been popular due to their favorable treatment under inheritance tax regulations, particularly for those with larger pots.

However, things have changed since the 2024 Budget announcement, and those with larger pots are now looking into a variety of ways to lower any potential IHT bill for their heirs. The "

How do pension savers avoid paying inheritance taxes?

Annuities and whole life insurance policies are two financial products that pension savers are increasingly using to get around the fact that pensions will be subject to inheritance tax starting in April 2027, according to Webb.

Annuity.

With annuities, savers can create a lifetime income stream out of all or part of their defined contribution pot. The "normal expenditure from income" exemption may be used to gift this income.

These gifts are immediately exempt from IHT as long as the regulations are followed.

If a joint life annuity is purchased, it continues even after the first person passes away. Even if the couple isn't married or in a civil partnership, this is exempt from inheritance tax for the second life.

Purchases of annuities with bigger pension pots have increased recently. According to data from the Association of British Insurers (ABI), sales of annuities valued at more than 250,000 increased by 31% year over year in 2025, while sales of annuities valued at more than 500,000 increased by 54%.

Because an annuity will pay out for a shorter period of time, people in worse health will typically receive a better rate.

Policies for a whole life.

Whole of life insurance policies allow savers to pay regular premiums for a policy that guarantees a lump sum payment upon the saver's death. If the policy is established under a trust, these payouts are exempt from inheritance tax.

Alternatively, any inheritance tax liability could be covered by this one-time payment.

When it comes to a couple, the policy can be configured to pay out on the second death, which means that it only does so when the estate is transferred between generations. This lowers the policy's price. This method, known as a joint life, second death policy, usually covers deaths up to age 90.

According to industry sources, demand for whole-life policies is expected to soar, with a 92 percent year-over-year increase reported in the spring of 2025.

Because the premiums will run longer and the expected payout date will be later, people in good health will typically have better terms for whole life policies.

"Defined contribution pension providers can expect to see changing behavior among savers with the largest pots, with more interest in drawing down more quickly for gifting or purchasing a whole-life policy, or even using the entire pot for purchasing an annuity," stated Webb. After retirement, providers might discover that the biggest pots vanish the fastest. The "

Which is better for avoiding inheritance tax: a whole-life policy or an annuity?

Financial advisors can suggest the best course of action for each individual, but according to Webb, pension savers are likely to take into account the following factors when choosing between an annuity and a whole-life policy.

Timing: The annuity option allows the pension saver to pass on regular income to their heirs while they are still living. A whole life policy, on the other hand, pays out a lump sum upon death.

Health: Although they run the risk of forfeiting their capital for a comparatively short payout period, those in poor health may be able to obtain favorable annuity terms. A whole-life policy, particularly one that only paid out on the second death in a couple, may offer favorable terms to those in good health.

Inflation adjustment: Whole life premiums can be set to rise in order to preserve the actual value of the final payout, or they can be fixed in cash terms, guaranteeing the policyholder can continue to make payments for the rest of their life.

In order to prevent HMRC from trying to add the money gifted (or spent on premiums) back into the estate after death, the policyholder must maintain records for both an annuity and a whole of life policy so their heirs can prove where the money went while the saver was alive.

Clare Moffat, a pensions and tax specialist at Royal London, stated: "It is evident that clients who may be impacted by IHT are becoming more interested in financial products like whole-life policies or annuities. However, the choices are complicated, and if an inheritance tax bill improves the situation for family members, it might be worthwhile.

"In order to determine the best course of action for their particular circumstances, the majority of people would benefit from seeking professional financial advice. A "

In a different article, we examine nine simple steps for navigating the inheritance tax paperwork maze.