Pension inheritance tax: what changes in April 2027?

For decades, pensions have been a powerful estate-planning tool for the simple reason that pension inheritance tax did not apply. If you died before you turned 75, your beneficiaries could usually inherit your pension tax-free. Even after 75, withdrawals were only taxed as income.

This meant that for years, anyone whose estate was likely to fall into the IHT bracket, could significantly reduce their exposure by holding wealth within a pension which generally fell outside their estate for IHT purposes.

But that solution will soon be vanished.

From April 2027, unused pension pots will no longer be automatically free from Inheritance Tax.

The government’s stated aim is to ensure pensions are used for retirement income, not as a vehicle for IHT mitigation . Pensions will no longer be the IHT-free inheritance tool they once were.

What’s actually changing?

Under the new rules, any pension wealth you haven’t drawn, whether in a SIPP, workplace pension, or drawdown plan may be counted as part of your estate for IHT calculations.

That means if your estate exceeds £325,000 then IHT could apply to the pension funds you leave behind. 40% of everything above the threshold could be taken by the taxman.

The age 75 distinction will also become less significant from an IHT perspective, as unused pension funds may be included within the estate regardless of the age at death. However, the age 75 rules will remain relevant for Income Tax purposes, as beneficiaries who inherit pension funds following a death after age 75 will generally pay Income Tax on withdrawals from those funds

Who will be affected by the pension IHT changes?

This change affects three groups:

People with large pension pots

If your pension is a major part of your wealth, your estate could now exceed the IHT threshold more easily.

People planning to leave pensions untouched

Many savers planned to use ISAs or cash first, leaving pensions to pass tax-efficiently to children. That strategy may no longer work.

People relying on the residence nil-rate band

If you inherit your spouse’s allowance, and your estate includes a family home, you might be able to leave an estate of up to £1 million with residence and spouse allowances before IHT becomes payable.

If your estate is already close to £2 million, pension wealth could reduce or eliminate your residence allowance.

The Residence Nil‑Rate Band is reduced by £1 for every £2 the estate exceeds £2 million, resulting in both a larger taxable estate and a reduction in the available Residence Nil-Rate Band.

What can you do about it?

The rule change means that you need a fresh look at your succession plans. Understanding how pension inheritance tax could affect your estate can help you review your options for leaving your wealth to your loved ones.

Before the change, it made sense to live on your ISAs and other investments in retirement. They are part of your estate, and subject to IHT, so running them down, while keeping a large pension intact was one way of defeating the taxman. This technique will no longer work.

But it is important to remember that the change affects unused pension pots, not income already taken. This means how and when you draw your pension becomes part of your estate-planning strategy.

Could an annuity help with pension IHT?

There could be one way to mitigate IHT charged on your pension pot. If you were to use it to buy an annuity, that annuity would be out of reach of the taxman. However, your wealth would usually go to the annuity provider on your death, offering no benefit to those you care about.

However, annuity income received during your lifetime could potentially be used to make gifts to beneficiaries. Where such gifts qualify for available IHT exemptions, including the normal expenditure out of income exemption, they may fall outside your estate for IHT purposes. The tax treatment will depend on your individual circumstances and whether the relevant conditions are satisfied.

Getting expert help

All UK tax is complicated, and finding ways to reduce your tax burden needs expert help.

If you are concerned about pension inheritance tax, reviewing your retirement and estate-planning arrangements sooner rather than later could give you more time to consider your options.

At Continuum, we can help you assess the potential impact of these changes on your wider financial plan and discuss the options that may be available to you.

We can help you review how you access your retirement savings and consider the potential impact on your wider financial and estate planning objectives.

The sooner you speak with us, the more time there is to review your circumstances and consider whether any changes may be appropriate.

Find out more about how Continuum can help you today.

This article is intended for general guidance only and is based on the opinion of Continuum it does not constitute financial advice. Individual circumstances vary, and you should consider seeking advice from a regulated financial adviser before making any decisions about your retirement and Inheritance tax planning.

The Financial Conduct Authority does not regulate taxation and trust advice or will writing.

A pension is a long-term investment; the fund value can go down as well as up and this can impact the level of pension benefits available. Pension Income could also be affected by interest rates at the time benefits are taken. Pension savings are at risk of being eroded by inflation.

The tax treatment depends on the individual circumstances of the investor and may be subject to change in the future. We recommend that the investor seeks professional advice on personal taxation matters.