Inheritance Tax Rules for Pensions Are Changing in 2027 – What You Need to Know

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If you’re thinking about what will happen to your assets after you pass away, it’s important to be aware of a major upcoming change in how pensions are treated for inheritance tax (IHT) purposes.

Currently, pensions usually fall outside of your estate for inheritance tax (IHT) purposes, and beneficiaries can often inherit these funds tax-free. However, from 6 April 2027, this is set to change: most unused pension funds and certain lump sum death benefits will be treated as part of your estate on death. This marks a significant shift in the law and could result in those pension assets becoming subject to IHT, depending on the overall value of your estate.

What’s Changing?

At the moment, pensions are often used as a tax-efficient way to pass wealth to the next generation. But from 2027, most unused pension funds (and certain lump sum death benefits) will form part of your estate for IHT purposes. That means:

  • If your estate exceeds the IHT threshold (currently £325,000 for most individuals), this could mean that your pension may now be subject to an inheritance tax charge at 40% (after any allowances are used).
  • This applies even though you’ve already paid into your pension from taxed income.
  • Spouses and civil partners will still benefit from the usual IHT exemptions.
  • In some cases, both IHT and income tax may apply — especially for non-spousal beneficiaries. This could potentially lead to a combined tax charge of up to 60-70%.

Why the Change?

The government has said that the current rules create an imbalance, allowing pensions to be used more for estate planning than retirement income. These changes aim to bring pension pots more in line with the way other assets are taxed on death.

Who Does This Affect?

This change is likely to affect individuals with defined contribution pension schemes, especially those who have accumulated sizeable pension savings and are planning to leave them untouched for beneficiaries. It may also impact those with estates already close to or exceeding the IHT threshold, and anyone intending to leave their pension to non-spousal beneficiaries, such as adult children or other relatives.

What Can You Do Now?

Although these changes won’t take effect until 2027, it’s important to start thinking ahead:

  1. Check your pension nominations – are they up to date? Do they reflect your wishes?
  2. Consider drawing down funds from your pension during your lifetime – Taking benefits during your lifetime could reduce the IHT exposure of your estate.
  3. Speak to a regulated financial adviser – They can help assess how this change may affect your broader financial and retirement planning.

As solicitors preparing Wills, we often remind clients that while a Will covers most assets, pensions are usually governed by separate nomination forms and don’t automatically follow your Will unless specific arrangements are made.

 

Written by Elin Jones, Trainee Solicitor (ej@passmores.com)