Is an annuity death benefit taxable?

Whether an annuity death benefit is taxable comes down to one date: your age when you die. If you die before 75, death benefits including lump sums and inherited drawdown pensions are typically taken free of Income Tax¹. If you die on or after 75, those benefits are usually taxed as income at the recipient's marginal rate¹.

The second thing that decides the answer is whether there is any death benefit at all. With many types of annuity, payments stop when you die². An annuity pays out after your death only if you chose death benefits when you bought it, and that choice cannot be made later: it needs to be set up when you buy your annuity, and you cannot add it afterwards³.

Where a payment is due and tax applies, the provider deducts income tax from the annuity using a tax code supplied by HMRC, so the beneficiary receives the money with tax already taken off⁴. Where the person died before 75 and the claim is settled in time, there is normally no income tax to pay at all.

An annuity pays out on death only if you added death benefits when you bought it

An annuity is a promise to pay you an income, and in its simplest form that promise ends with you. With many types of annuity, payments will stop when you die². A single life annuity bought without any protection pays nothing to anyone after the annuitant dies, and the capital used to buy it is gone.

Death benefits are not automatically payable⁸. What happens depends on the arrangements put in place when the annuity was purchased, such as a guarantee period, a joint life annuity or value protection⁸. Those are the three main ways an annuity can keep paying after death, and each works differently.

The timing rule is the one people most often miss. Death benefits need to be set up when you buy your annuity, and cannot be added later³. There is no window after purchase in which to change your mind, and no provider route to add protection to an existing policy. That makes the purchase decision the only one that counts.

It also means the cost is paid up front. Adding a joint life option, a guarantee period or value protection reduces the income the annuity pays while you are alive, because the provider is taking on the risk of paying out for longer. The trade-off is between a higher income for one person and a lower income that continues, or returns value, after death.

Joint life, guaranteed term and value protection: how each one pays out

The three options behave in quite different ways, and a buyer can combine more than one.

A joint life annuity continues to a named beneficiary, usually at two thirds or half of the original payments². It is designed for couples, and the reduction reflects the fact that one household is now being supported rather than two people's needs being met from the same income. These will pay an income to your spouse or partner after your death, but this is usually at a lower rate⁹.

A guarantee period works differently: the annuity income stops when you die unless there is any guarantee period outstanding or you opted for a spouse's pension¹⁰. A guarantee period fixes a minimum number of payments, so if you die early the remaining instalments go to whoever you nominated.

Value protection is the third route. When you die, this type of annuity pays out any difference between your total received annuity payments and the amount you originally bought it for¹¹. If you bought an annuity with £100,000 and had received £40,000 in payments when you died, the difference is paid as a lump sum to your beneficiaries.

Death before 75: income and lump sums usually free of income tax

If someone dies before their 75th birthday, most lump sums paid from their pension are tax-free up to a limit¹². The same principle covers income: if it is taken as income drawdown or an annuity, there will be no income tax to pay, and if it is taken as a lump sum then the position depends on the allowance¹³.

The limit is the Lump Sum and Death Benefit Allowance. If you die before age 75, any lump sums your beneficiaries get that are within your remaining lump sum and death benefit allowance will normally be free of income tax, and the excess will normally be taxable at your beneficiaries' marginal rate¹⁴. Death benefits are paid tax-free to beneficiaries providing they are paid within two years of the pension provider being notified, or ought to have reasonably known, of the death¹⁵.

The allowance itself is £1,073,100 for most people, and it counts tax-free lump sums taken from your pension before and after you die⁵. It incorporates both tax-free lump sums an individual takes while alive and lump sums paid on death¹⁶. That means a large tax-free cash withdrawal during your lifetime uses up part of the same allowance that would otherwise shelter a death benefit.

Death after 75: taxed at the beneficiary's income tax rate

Where the annuitant died at 75 or over, the tax position changes completely. Benefits are usually taxed as income at the recipient's marginal rate¹. If you die when you are 75 or over, your beneficiaries will have to pay income tax on any income they take from your drawdown plan², and the same logic applies to annuity payments: if you die age 75 or above, your beneficiaries will pay tax on annuity payments at their marginal rate¹⁷.

The rate is not fixed. It depends on the beneficiary's own income, so a beneficiary paying basic rate pays basic rate on the inherited income, and one paying higher rate pays higher rate. If you die after you are 75, your beneficiaries may have to pay income tax on the money¹⁸, and death benefits after age 75 are subject to income tax at the recipient's applicable rate¹⁹.

This is why the same annuity can produce different outcomes for two different beneficiaries. Both lump sum withdrawals and regular income, taken through income drawdown or an annuity, will be taxed at your beneficiary's marginal rate of income tax²⁰. If you die after the age of 75, anyone who inherits your pension will be taxed on any income received as earnings at their marginal rate of tax, whether it comes as an annuity, a scheme pension or flexible drawdown²¹.

The practical effect is that inherited annuity income is treated much like a salary. It is added to whatever else the beneficiary earns, and it can push them into a higher band. Where tax is due, the provider deducts it using a tax code from HMRC⁴.

Inheritance tax on annuity death benefits and the coming change

Income tax and inheritance tax are separate questions, and an annuity can be exposed to one without the other. Income from annuities will not be subject to inheritance tax²². That has been the long-standing position for single life and joint life annuities, and it is why annuities have sometimes been described as inheritance tax efficient compared with other ways of holding retirement money.

That is changing for pension money more broadly. Unused pension funds and death benefits payable from a pension are brought into a person's estate for inheritance tax purposes from 6 April 2027²³. The same date appears in the consultation outcome: most unused pension funds and death benefits would be included in the value of a person's estate for Inheritance Tax from 6 April 2027¹.

Two details matter for anyone planning around this. From that date, personal representatives will be liable to report and pay any Inheritance Tax due on unused pension funds or death benefits⁷. And all death in service benefits payable from a registered pension scheme will be excluded from the value of an individual's estate for Inheritance Tax purposes from 6 April 2027⁷.

Claiming death benefits: who receives them and the two-year limit

Who receives the money is decided by the nomination held by the provider, not by the will. Inheritance tax, where it applies, is paid by the executor of the Will²⁴, but the annuity provider pays death benefits to the person or people named on the policy. Keeping that nomination current is the single most useful thing an annuity holder can do.

There is no requirement for a beneficiary to be a relative or a financial dependant. You can nominate whoever you choose, and the provider will pay them. The dependant rules that apply in some workplace schemes do not restrict a personal annuity nomination.

The deadline is the part that catches people out. HMRC currently allows up to two years for a payment to be made before it is potentially subject to a tax charge⁶. If your loved ones do not claim your death benefits within a certain time period, currently set at two years, they may lose the tax-free treatment¹⁵. If it has not been established who is to receive death benefits from your pension within two years of your death, the position changes¹³.

Once the two years have passed, or if the person died after 75, the options narrow. After two years of notification of death, or if you die after age 75, your beneficiaries have the same options, but they will have to pay income tax on the benefits and the LSDBA will not apply¹⁴. If the deceased was over age 75 when they died, or the claim takes over two years to settle, all benefit payments, whether lump sum, annuity or drawdown, will be subject to income tax against whoever the benefit is paid to²⁵. If you died after age 75, or the claim was not settled inside two years, then the income will be subject to tax as earned income by your beneficiaries under PAYE rules¹⁶.

Where to get help

Free, impartial guidance is available from Pension Wise for anyone with a defined contribution pension, covering the options for taking money and what happens to it afterwards. MoneyHelper covers the same ground for consumers generally. Where a dispute arises with a provider over a death benefit claim, the Pensions Ombudsman can look at complaints about how a scheme or provider has handled it, and HMRC currently allows up to two years for a payment to be made before it is potentially subject to a tax charge⁶.

For the wider picture on what happens to pension money after death, see what happens to your pension when you die and pensions and inheritance tax. The rules on how annuities are bought and what they pay are set out in annuities explained, and the allowances that cap tax-free payments are covered in tax-free cash from your pension and the lump sum allowances.