All about annuities, drawdown and IHT
Did you know that almost half of London is green space and at this time of year it is at its greenest. The most common tree in London is called the Plane Tree, with its ability to survive high levels of pollution and it comes into leaf in May spreading greenness across our capital. Many of London’s larger green spaces had their origins during the reign of Henry VIII who used them as grounds to hunt deer, the odd rabbit and possibly wild boar. I have seen many deer in Richmond Park and on Bushy Common but I don’t recall ever seeing a rabbit in a London green space and certainly not a Wild Boar.
May also sees the Chelsea Flower show, which has been an annual event held in the grounds of the Royal Chelsea Hospital since 1913 and has its origins far earlier than that. In 2026 the Royal Horticultural Society will lift its ban on Garden Gnomes for only the second time in its history in honour of King Charles III who apparently has a cherished gnome in his garden at Highgrove. A number of celebrities will paint gnomes for the event which will run between 23 and 26 May 2026.
Something less green but equally topical is the subject of annuities. If you or a client has a pension fund that you or they are not likely to need income from, does it make sense to take an annuity, pay tax on the income and use the net income to pay for a guaranteed whole of life (GWOL) policy to cover or partially cover Inheritance Tax (IHT) payable upon death and or to provide a “nest egg” for their family. Taking this a step further, how about drawing down on a pension, paying income tax and using the net of tax income to pay for a GWOL?
In all scenarios, consideration must be given to the IHT treatment of the premiums paid to fund the GWOL. It is important the gifts out of surplus income IHT exemption is available, otherwise the premiums could be exposed to IHT.
Every situation is different, which is why it is important to take advice on your own or your client’s situation and this hopefully is where we come in, please! But for now, we have run various different scenarios and these look to support the thinking in the paragraph above.
Let’s assume we have an individual who has decided, after discussion with their spouse or civil partner, that they do not need their pension fund of £1m. For the sake of simplicity we assume they have already taken their maximum pensions commencement lump sum (we will look at this in a future “Down the Lane”.)
The tables below show the annuity that can currently (May 2026) be acquired at different ages with a £1m fund and the amount of GWOL that can be acquired post income tax, with the annuity payment. The first table considers a flat annuity, the second an RPI linked annuity. The third table looks at a SIPP valued at £1m to start with and what this may have grown to by the age at which normal life expectancy is attained (see below) and what the post tax position will likely be, although tax rates and tax rules may well have changed by then.
Joint last survivor – no indexation. (both same age)
| Age | Approximate pension annuity – £1m purchase | Annuity net of tax at 40% | Approx GWOL purchased | Annuity net of tax at 45% | Approx GWOL purchased |
|---|---|---|---|---|---|
| £ | £ | £ | £ | £ | |
| 70 | 71,000 | 42,600 | 2.0M | 39,050 | 1.9M |
| 75 | 80,000 | 48,000 | 1.7M | 44,000 | 1.6M |
| 80 | 94,000 | 56,400 | 1.5M | 51,700 | 1.4M |
Joint life last survivor –RPI linked (SIPP value £1m, both same age)
| Age | Approximate pension annuity (5% p.a. escalation) £1m purchase | Annuity p.a. net of tax at 40% | GWOL purchased (40%) | GWOL final payout assuming RPI at 3% p.a. to normal life expectancy | Annuity p.a. net of tax at 45% | GWOL purchased (45%) | GWOL final payout assuming RPI at 3% p.a. to normal life expectancy |
|---|---|---|---|---|---|---|---|
| £ | £ | £ | £ | £ | £ | £ | |
| 70 | 43,100 | 25,860 | 1.2M | 2.0M | 23,705 | 1.1M | 1.8M |
| 75 | 52,500 | 31,500 | 1.1M | 1.6M | 28,875 | 1.0M | 1.4M |
| 80 | 67,400 | 40,440 | 1.05M | 1.4M | 37,070 | 0.9M | 1.2M |
SIPP (starting value £1m)
| Age | SIPP value at normal life expectancy (assumed growth 4% p.a. net of charges) | SIPP value less 40% IHT less 40% income tax on beneficiary drawdown | SIPP value less 40% IHT less 45% income tax on beneficiary drawdown |
|---|---|---|---|
| £ | £ | £ | |
| 70 | 1.94M | 698,400 | 640,200 |
| 75 | 1.67M | 601,200 | 551,100 |
| 80 | 1.48M | 532,800 | 488,400 |
Index linked v flat annuity?
Clearly an RPI linked annuity is more expensive than one which does not escalate. However a 70 year old is likely to live for a further 15 years (male) and 17 years (female.) At 75 average life expectancy is 11 years (male) and 13 years (female) and at 80 average life expectancy is 8 years (male) and 10 years (female.) * During this time it is highly likely that the value of the drawdown fund will increase substantially, whereas a flat annuity and the GWOL it pays for will not.
However, this is where matters became quite complicated and steam started to come out of our collective ears. It is possible to set the indexation on both the annuity and the GWOL to RPI, but the problem is the annuity RPI increase element will be taxable (as is the annuity payment itself) and will not therefore be available to fully fund the increased GWOL premium. We have therefore set the annuity at maximum escalation of 5% before tax and the GWOL increase at RPI. There is a risk that if RPI increases more quickly than the 5% annuity increase (net of tax) the payer will be out of pocket. At this point it may be possible to pause or switch RPI linking off on the GWOL, but the availability of this facility will vary between insurers
What about flexi access drawdown?
With non-invested joint life annuities there is no investment risk; the annuity is payable for life and can fund the GWOL premiums for life. Introducing an invested pension fund into the mix does complicate matters, as there is then a risk that the pension fund could become depleted and therefore unable to continue funding the GWOL premiums. This of course depends on investment performance and charges.
Nonetheless, based on the calculations below, which consider different investment returns, it is apparent that the SIPP in drawdown can fund equivalent GWOL premiums to the annuities considered above and will also leave a residual post tax fund in all but one scenario.
This assumes that the last life assured under the GWOL lives to their normal life expectancy; if they live longer than this, they have to continue paying the GWOL premiums for the whole of life and the value of the SIPP continues to decrease meaning they would have been better off with an annuity. At age 70 normal life expectancy is 87and so a 40% tax paying 70 year old living to age 100 and paying £42,600 p.a. in GWOL premiums will need to draw for an additional 13 years from their SIPP at £71,000 p.a. leaving them over £800,000 out of pocket when compared to the outcome had they taken a annuity.
SIPP starting value £1m – grows at 2% p.a. net of all charges
| Age | Annual drawdown required pre-40% tax to fund £2.05M GWOL (net premium £42,600) | Annual drawdown required pre-45% tax to fund £1.89M GWOL (net premium £39,050) | Residual SIPP fund at normal life expectancy | Residual SIPP value less 40% IHT less 40% income tax on beneficiary drawdown | Residual SIPP value less 40% IHT less 45% income tax on beneficiary drawdown |
|---|---|---|---|---|---|
| £ | £ | £ | £ | ||
| 70 | 71,000 | 71,000 | (92,000) | 0 | 0 |
| 75 | 80,000 | 80,000 | 42,000 | 15,120 | 13,860 |
| 80 | 94,000 | 94,000 | 100,000 | 36,000 | 33,000 |
SIPP starting value £1m – grows at 4% p.a. net of all charges
| Age | Annual drawdown required pre-40% tax to fund £2.05M GWOL (net premium £42,600) | Annual drawdown required pre-45% tax to fund £1.89M GWOL (net premium £39,050) | Residual SIPP fund at normal life expectancy | Residual SIPP value less 40% IHT less 40% income tax on beneficiary drawdown | Residual SIPP value less 40% IHT less 45% income tax on beneficiary drawdown |
|---|---|---|---|---|---|
| £ | £ | £ | £ | ||
| 70 | 71,000 | 71,000 | 205,000 | 73,800 | 67,650 |
| 75 | 80,000 | 80,000 | 268,000 | 96,480 | 88,440 |
| 80 | 94,000 | 94,000 | 271,000 | 97,560 | 89,430 |
SIPP starting value £1m – grows at 6% p.a. net of all charges
| Age | Annual drawdown required pre-40% tax to fund £2.05M GWOL (net premium £42,600) | Annual drawdown required pre-45% tax to fund £1.89M GWOL (net premium £39,050) | Residual SIPP fund at normal life expectancy | Residual SIPP value less 40% IHT less 40% income tax on beneficiary drawdown | Residual SIPP value less 40% IHT less 45% income tax on beneficiary drawdown |
|---|---|---|---|---|---|
| £ | £ | £ | £ | ||
| 70 | 71,000 | 71,000 | 660,000 | 237,600 | 217,800 |
| 75 | 80,000 | 80,000 | 580,000 | 208,800 | 191,400 |
| 80 | 94,000 | 94,000 | 490,000 | 176,400 | 161,700 |
Birchin Lane Wealth Advisory Limited is an authorised representative of Prosper Financial Solutions Limited which is authorised and regulated by the Financial Conduct Authority. Tax and general wealth planning advice is not regulated by the Financial Conduct Authority.
Birchin Lane Wealth Advisory Limited is entered on the Financial Services Register under reference 1023322.
Registered address 71-75 Shelton Street London WC2H 9JQ. Company number 16101332
The information contained herein does not contain and should not be construed as any form of advice, including tax or
financial advice. Investors should independently assess, with a professional financial advisor, tax advisor, lawyer and
accountant, the specific financial risks as well as legal, regulatory, credit, tax and accounting consequences.
This document constitutes marketing material only and has been produced by Birchin Lane Wealth Advisory Limited.
Although information in this document has been obtained from sources believed to be reliable, Birchin Lane provides
no guarantee regarding the timeliness, accuracy, or completeness of the information. To the full extent permissible by
law, Birchin Lane shall not be responsible for the consequences of any errors or omissions herein, or reliance upon
any opinion or statement contained herein, and Birchin Lane expressly disclaims any liability, including (without
limitation) liability for incidental or consequential damages, arising from the same or resulting from any action or
inaction on the part of the recipient in reliance on this and does not accept any liability for any loss or damage
resulting from its use.
This document is intended for information purposes only and does not constitute an offer, any form of
recommendation or an invitation by, or on behalf of, Birchin Lane to make any buy, sell, hold or solicit, any investment,
security, other financial instrument or other product or service. The information in this document does not consider the
specific investment objectives, financial situation, tax situation or needs of the recipient and certain products
mentioned may not be suitable for you. You should seek your own professional advice (including tax advice) suitable
to your circumstances prior to making any investment or if you are in doubt as to the information in this document.
The information provided herein is for the exclusive use of the recipient and may not be reproduced, disclosed or
distributed, neither in part nor in full. The information and views expressed in this document at the time of writing are
subject to change at any time without notice and there is no obligation to update or remove outdated information. Past
performance is not a reliable indicator of future results and the value of investments may fall as well as rise.
This document is not directed at, or intended for distribution to or use by, any person or entity domiciled or resident
in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable laws or
regulations of such jurisdictions.
Neither this document nor any copy thereof may be sent, taken into or distributed in the United States or to US
persons.
