Pensions have long been viewed as a tax-efficient way to save and invest for the future. Until recently, they also offered favourable treatment when passed on through inheritance, as they have typically fallen outside the scope of Inheritance Tax (IHT).
However, the chancellor announced in the Autumn Budget that pensions will no longer be exempt from IHT after April 2027. This means that, under the proposed rules, part or all of your pension could become subject to tax when you pass away.
It’s important to note that the full details have yet to be finalised and are still under review. The final rules may change before they come into effect, but it’s a good idea to prepare for them anyway.
Read on to find out what the proposed changes entail and how they could affect you.
Until now, pensions haven’t typically been considered part of your estate
Under the current rules, defined contribution (DC) pensions are not considered part of your estate and are typically exempt from IHT. Defined benefit (DB) pensions are also generally outside the scope of IHT, although this can vary depending on the specific scheme and provider.
This means that if you die before age 75, your remaining pension pot can usually be passed on tax-free. If you die after age 75, your beneficiaries may need to pay Income Tax on any withdrawals, but IHT doesn’t usually apply.
However, from 6 April 2027, this is set to change. Under new proposals, pensions will become subject to the standard IHT rate of 40%. The tax would need to be paid within 60 days of death, and the funds may not be released to your beneficiaries until this is settled. It will be the responsibility of the pension provider to calculate and report the tax that is due.
Only a handful of estates will be affected by the changes, but it’s important to prepare for them
The latest figures from the UK government show that just over 4% of estates currently pay IHT. However, the upcoming changes are expected to widen the net.
Government estimates suggest that an additional 10,500 estates will become liable for IHT for the first time, and around 38,500 will face higher IHT bills as a direct result of the new rules.
These figures remain relatively low due to the use of nil-rate bands – the thresholds below which no IHT is due. For individuals, this can reach up to £500,000 when including the residence nil-rate band, and up to £1 million for married couples or civil partners who combine allowances.
Additionally, many people draw down a substantial portion of their pension during retirement, reducing what’s left in their pot at death.
That said, with the changes taking effect from 6 April 2027, it’s important to start planning now. Reviewing your estate plan, including how your pension is passed on, can help minimise potential tax liabilities and ensure your wealth is distributed according to your wishes.
How to mitigate the effect of the changes to pensions and Inheritance Tax
With changes to IHT rules on the horizon, you may want to start exploring strategies that will help limit your estate’s future liability.
For example, you might consider giving away more during your lifetime, particularly if you’ve already inherited a pension from a spouse. This could involve gifting lump sums or contributing to pensions or ISAs for your children, grandchildren, or other loved ones.
To do this effectively, it may make sense to draw more from your own pension while you’re alive, which can help reduce its overall value and, in turn, lower the IHT burden on your estate.
But it’s important that your own needs still come first. So, it’s a good idea to ensure you have enough to maintain your desired lifestyle throughout retirement and to cover unexpected expenses or long-term care before making gifts.
You may also need to review and update your will to ensure your estate plan reflects your current wishes and is structured in a way that best supports your beneficiaries.
A financial planner can work with you to determine the most tax-efficient way to draw income in retirement and to pass on your wealth after your death. They can help you create a withdrawal plan to maximise your pension’s efficiency and update your estate plan to ensure your beneficiaries are best supported.
Get in touch
With the changes to pensions and IHT coming in 2027, it’s a good idea to start planning for them now.
To find out more about how these changes could affect you and what steps you can take to protect your legacy, get in touch.
Email us at hello@vwmwealth.com or call us on 0141 229 4004.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, cashflow planning, tax planning, trusts, Lasting Powers of Attorney, or will writing.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
