Immediate inheritance tax saving
Peter McGahan
Monday 28th September, 2026.
INHERITANCE tax planning - sometimes you know you have too much money, but you aren't terribly enthusiastic about giving it away.
Hardly irrational.
Suppose you have £1million sitting in deposits and investments which you know you are unlikely to spend (like you do). If it remains in your estate until death and sits above your available exemptions and allowances, some of it could ultimately suffer inheritance tax at 40 per cent.
Giving it to the children sounds obvious. But an outright gift normally needs you to survive seven years before it falls completely outside the inheritance tax calculation. More importantly, you've given the money away. It's theirs.
That second bit has a habit of concentrating the mind.
What if you want to reduce the capital in your estate now, but still need an income from it for the rest of your life? There are a few options for that - here’s one.
That's where a purchased life annuity (PLA) can become interesting.
You take, say, £500,000 of surplus capital and use it to purchase an annuity from an insurance company. In exchange for handing over that capital, the insurer promises to pay you an income for life.
The important bit for inheritance tax planning is what has happened to the £500,000.
You have spent it purchasing something for yourself - a lifetime income.
When you die, the annuity itself normally has no value in your estate because the entitlement to its income has ended.
So, we've solved one problem remarkably quickly and created another one.
The £500,000 has disappeared from your estate because you've exchanged it for an income which dies with you. That's splendid for the tax calculation, but your children might reasonably point out that they were rather hoping to inherit the £500,000.
Enter part two: the life assurance.
So, you arrange life cover for, say, that £500,000. The death benefit of £500,000 is placed into trust to go straight to your beneficiaries which doesn’t form part of your estate for Inheritance tax.
Capital inside your estate is exchanged for a lifetime annuity, which is now immediately outside your estate rather than waiting seven years to work fully for inheritance tax. The annuity provides you with income while you are alive. Life assurance then seeks to replace the capital for your beneficiaries when you die.
Naturally, anything which appears that neat deserves a firm prod with a stick before you buy it.
First, this isn't simply a clever way of converting capital into “income” and then claiming the life assurance premiums are automatically exempt gifts. HMRC has specific anti-avoidance legislation dealing with life policies connected with annuities, the so-called back-to-back rules.
Whether the annuity and insurance are associated operations therefore matters enormously. HMRC's published practice includes important conditions around full medical underwriting and whether the life policy would have been offered on the same terms without the annuity.
This is specialist planning, not something to assemble yourself on a wet Sunday afternoon.
There's certainty too. Unlike leaving £500,000 invested and hoping investment returns, withdrawals and markets all behave themselves, the annuity provides a contractual income for life.
And longevity can work rather nicely. Live considerably longer than the insurer's assumptions and those payments keep coming. There are worse financial problems than stubbornly refusing to die.
But don't ignore what you've surrendered.
The capital is generally gone. You can't buy a lifetime annuity with £500,000 and then wander back five years later asking for your £500,000 because you've changed your mind. That loss of access should be considered.
Death benefits matter too. Guarantees, capital protection or payments continuing after death may be available on some annuities, but they change the estate-planning consequences. The whole point here needs to be understood before adding bells which accidentally undo it.
Inflation can quietly nibble away at a level annuity income, while escalating income normally starts lower.
And life assurance isn't free. Age and health can make the premiums expensive or cover unavailable. The cost of replacing the capital has to be compared with the tax potentially saved, the annuity income received and the alternatives available.
That's the real calculation.
Don't begin with an annuity. Don't begin with life assurance. Begin with the problem.
How much capital do you genuinely never expect to need? What tax might arise if you retain it? What income would exchanging that capital produce? What would suitable life assurance cost? What access are you surrendering?
A purchased life annuity and life assurance can create an intriguing estate-planning combination.
Doing so without accidentally taking financial security away from yourself is the right way.
If you would like an illustration as to how that can work, please email info@wwfp.net
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
