Changes to inheritance tax (IHT) on pensions from 2027

As part of the 2024 Autumn Budget, Chancellor Rachel Reeves announced a number of measures to reform inheritance tax (IHT). 

One of these measures is to include unused pension funds and specific death benefits as part of a person’s estate for inheritance tax purposes, effective from 6 April 2027.

Please note that details aren't yet finalised and things could change. However, it’s still important to be aware of potential changes that could affect your retirement savings in the future.

Tax treatment depends on your individual circumstances and may be subject to change in the future.

How does IHT on pensions work currently?

As things currently stand, unused pension savings aren’t considered part of your estate, and therefore don’t usually count towards IHT. This makes pensions a valuable tool for those looking to build wealth for future generations in a tax-efficient way.

Many pension schemes include what are known as ‘death benefits’. These come into effect when the pension holder passes away and often allow remaining pension funds to be transferred to beneficiaries. In most cases, these benefits fall outside of the estate for inheritance tax purposes.

Death benefits can be passed on in different forms, and tax treatment depends on how old you are when you die. If you pass away before reaching 75, your beneficiaries can usually receive the pension funds tax-free, as long as:

• The amount left as a lump sum is within the Lump Sum Death Benefit Allowance (currently £1,073,100). Amounts over this limit are taxed at the recipient’s marginal income tax rate.
• Or, the pension is left in the form of a drawdown or annuity.

If you die at age 75 or older, your beneficiaries will need to pay income tax at their personal rate on any funds they withdraw – whether as a lump sum, annuity or through a drawdown.

Bear in mind, not every pension plan includes death benefits, so be sure to check the details of your specific scheme.

How is this set to change?

From 6 April 2027, most unused pension savings and death benefits could potentially be included in your estate and may be subject to inheritance tax.

These changes will affect both defined contribution and defined benefit pension schemes, and mean that if your estate exceeds the current inheritance tax threshold (currently £325,000), the amount above that limit could be taxed at 40%.

There are, however, some exceptions. Pension death benefits passed onto a UK-domiciled spouse or civil partner will remain exempt. Additionally, scheme pensions for dependants and lump sums donated to charities will not be subject to inheritance tax.

Please note that these changes will apply to all pension arrangements – whether registered in the UK or qualifying overseas schemes.

How might this affect you?

From 2027, people that inherit a pension could be liable for both income tax and inheritance tax on what they receive. This means that if you die after turning 75, your beneficiaries could face a total tax charge as high as 67%.

Because of this, you may need to rethink your estate planning strategy – especially if you’ve been relying on pensions as a tax-efficient way to pass on your wealth. Pensions may no longer be the best option, and it could be time to explore other strategies for managing and passing on money.

Under the current rules, you may be choosing to spend other savings first (for example, an ISA), while leaving most of your money in your pension. This can help reduce the amount of tax your loved ones may have to pay later – however, this strategy may not work as well when the new rules come into effect.

How to plan for these changes

With new rules set to impact how pensions are treated after death, careful planning is more important than ever. Strategies that once made pensions a tax-efficient way to pass on wealth may soon need to be reconsidered.

Here are are some practical steps you can take to stay ahead of the changes and make informed decisions for your future.

• Review your current estate planning strategy – A good place to start is by assessing the significance of your pensions within your estate plan. You can then determine how much of an impact these changes could have on your future planning.
• Consider alternative financial planning strategies – In light of the changes, you might want to explore alternative strategies for retirement planning. This may be using pension savings earlier (known as a ‘decumulation strategy’), transferring your wealth sooner (early inheritance) or gifting from regular income (using your current gift allowance of £3,000).
• Seek specialist financial advice – Speaking to a Specialist Financial Adviser can be a valuable step in understanding the full impact these new rules could have on your estate. They can review your current plans to identify any potential risks, help you to restructure your assets and advise on strategies to help you make the most of your money during retirement. With expert advice, you can feel confident that your wealth is protected and your loved ones are looked after – whatever the future holds.

Please note advice charges may apply. The Financial Conduct Authority (FCA) does not regulate inheritance tax planning and trusts.