For years, pensions have been one of the most tax-efficient ways to pass on wealth in the UK.
However, significant changes are coming that could reshape how your retirement savings are taxed when you pass away and your pension is inherited by beneficiaries.
Following announcements in the Autumn Budget 2024 and confirmed in the Finance Act 2026, the government is introducing major reforms to how pensions are treated for inheritance tax (IHT). These changes could affect your estate planning—and more importantly, what your loved ones ultimately receive.
In this article, we explain what’s changing, who could be affected, and what you should be doing now.
Current Position
Under the current IHT legislation, most pension funds are outside of an estate for Inheritance Tax purposes.
This means that the value of a pension fund at the date of death is not subject to IHT and can often be passed tax-efficiently to beneficiaries under your Will.
In addition, if you pass away before age 75, typically a pension fund can be accessed by a nominated beneficiary free of income tax (subject to the lifetime limit).
The favourable tax treatment of pensions has made them a popular estate planning tool for IHT purposes.
Typically, many individuals have deliberately persevered their pension (due to it being excluded from IHT) and have spent from other assets and investments in priority as to reduce the value of any assets which may chargeable to IHT.
Position from 6 April 2027
The IHT position for most pensions from April 2027 change significantly and means the value of the majority of unused pension funds will be included within your estate for Inheritance Tax.
In practice, this means the value of unused pension funds will be charged to IHT at 40% where the value exceeds any available allowances and applies regardless of whether you pass away before or after reaching the age of 75.
If you pass away before reaching age 75, pension funds inherited by beneficiaries can still be withdrawn free of income tax as before.
Bringing pensions into the charge of IHT removes a valuable estate planning tool and will be a costly change for many. HMRC are estimating that a further 10,500 estates will become liable to IHT when pensions are brought into IHT calculations from April next year.
What do the changes mean in practice?
Aside from increasing the amount of IHT due on estates, the new changes from April 2027 will add further administrative challenges for Executors who will be required to:
- Identify pension schemes;
- Obtain valuations of any remaining pension funds; and
- Report the value of the pension forms on IHT Returns.
IHT must be paid typically within six months of date of passing, and some pension funds may withhold up to 50% of the value of the pension fund until any IHT due is settled. Under current plans, pensions schemes may also be able to pay IHT directly to HMRC on behalf of Executors.
In addition to the administrative aspects, bringing pensions into the scope of IHT has further implications such increasing the overall value of an estate which counts towards the tapering of the Residence Nil Rate Band (worth £175,000 per individual) when an estate exceeds £2,000,000 in value. In some circumstances this can increase the amount of IHT payable on a main residence where it is being left to a lineal descendant.
Double Tax Trap
Due to IHT now being chargeable on pension schemes, when beneficiaries of a pension come to withdraw from the fund from someone who passed away after age 75, they will be required to pay income tax on any withdrawals made from the pension.
The income tax due on the pension withdrawal will be assessed at the beneficiary’s marginal rate of income
tax (20%, 40% or 45%).
Therefore, an effective rate of up to 67% can apply once IHT and income tax have been accounted for from pension withdrawals, meaning the changes can be very costly overall.
What can be done now?
With now less than a year until pensions become chargeable to IHT, there are some planning actions which can be taken before 6 April 2027 to help mitigate the impact of the changes:
- Reviewing pension nominee forms;
- Reconsidering the order in which pensions and savings are accessed;
- Exploring other savings options which can be more IHT-efficient
- Reviewing whether insuring against the IHT will be beneficial;
- Considering making regular gifts out of pension income; and
- Exploring other planning options to help mitigate the likely Inheritance tax liability.
It is important to note that pension funds left to a surviving spouse continue to be free of IHT. However, any ultimate beneficiaries after the surviving spouse deceases will be subject to IHT.
If you would like to review the impact of the pension changes and consider effective estate planning, please do not hesitate to get in touch.
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