Pensions and Inheritance Tax: what’s changing from April 2027?

From 6 April 2027, any unused pension funds will be included in your estate for Inheritance Tax (IHT) purposes. This is an important change, as pensions have traditionally sat outside the IHT net.

What is changing?

At present, most pension death benefits are paid at the provider’s discretion and are not included in your estate when IHT is calculated. From April 2027, unused defined contribution pensions will be added to your estate value.

If the total value of your estate, including your pension, exceeds the available IHT allowances, tax at 40% may be due on amounts above those limits.

Defined benefit pension schemes, such as final salary or career average pensions, are not affected by this change. These schemes usually pay a dependant’s pension rather than a lump sum and do not form part of your estate for IHT purposes.

The intention behind this change is to encourage pensions to be used to support retirement, rather than being preserved mainly as an inheritance planning tool.

Will this affect everyone?

No. If your estate remains within the available IHT allowances, there will be no Inheritance Tax to pay. Many estates will continue to fall below these thresholds.

However, individuals with larger defined contribution pension funds or higher overall wealth may see an increased IHT bill. HMRC estimates that around 10,500 more estates each year will be affected as a result of this change.

Key points to understand

• Pensions left to a spouse or civil partner remain IHT free
  There is no IHT to pay when pension funds pass to a surviving spouse or civil partner. IHT only arises when the money later passes to other beneficiaries, such as children.
• Pensions left to children may face IHT
  Pension benefits paid to non‑exempt beneficiaries could be taxed at up to 40%, depending on the size of the estate and available allowances.
• Large estates could lose other allowances
  Including defined contribution pensions in the estate may push total wealth above £2 million, which can reduce or remove the residence nil‑rate band. This could significantly increase the overall IHT bill.
• More administration for executors
  Pension values will need to be included in IHT calculations, and part of the pension may be used to settle the tax before benefits are paid to beneficiaries.

What does not change?

• Pension growth remains free from Income Tax and Capital Gains Tax
• Pensions usually sit outside probate
• Income tax rules on inherited pensions stay the same. If death occurs before age 75, beneficiaries can usually take pension benefits tax free. If death occurs after age 75, withdrawals are taxed as income
• Defined benefit pension schemes are unaffected
• Pensions remain an effective and flexible way to save for retirement

What should you consider next?

• Review your beneficiary nominations to make sure they remain appropriate
• Revisit your retirement income strategy, particularly if you were preserving pensions mainly for IHT reasons
• Plan for how any future IHT bill could be funded, for example through savings or life insurance held in trust
• Consider gifting or charitable planning if you have surplus wealth and leaving a legacy is important to you

In summary

These changes do not mean that everyone will pay Inheritance Tax. However, they do reinforce that defined contribution pensions should primarily be viewed as retirement assets, rather than IHT shelters.

With early planning, it is often possible to reduce the impact and avoid surprises for your family. If you would like to understand how these changes could affect your personal circumstances, please speak to your usual adviser.