From 6 April 2027, significant changes to Inheritance Tax (IHT) will bring most unused pension funds into scope for IHT calculations on death. This could increase the tax payable on an estate, reduce the amount passed to beneficiaries, and in some cases result in both IHT and Income Tax being applied to inherited pension funds. As a result, individuals may need to reconsider existing estate planning strategies and review how their pension wealth fits within their overall succession plans.
What changes are being made to inheritance tax in 2027?
From 6 April 2027, most unused pension funds will be included as part of your estate for Inheritance Tax (IHT) purposes.
For many years, pension funds have generally been outside an individual’s estate when calculating IHT. The Government has announced that this will change, meaning many pension funds may become subject to IHT on death.
Why do the changes matter?
For some individuals, these changes could significantly increase the amount of tax payable on death and reduce the value ultimately inherited by their beneficiaries.
In some circumstances, pension funds may be subject to:
- Inheritance Tax as part of your estate; and
- Income Tax when beneficiaries withdraw funds from the inherited pension pot.
Depending on the circumstances, the combined tax burden could be substantial.
Historically, many people have chosen to preserve their pension funds for as long as possible and use other assets first, as pensions have generally been outside the scope of IHT. Once the new rules take effect, this approach may no longer be the most tax-efficient strategy.
How could the inheritance tax changes affect you?
Including pension funds within your estate may increase your exposure to IHT and reduce the amount passed on to future generations.
There are two key ways in which this could affect your family:
1. Additional tax may be payable on your pension fund
Unless pension benefits pass to a surviving spouse, civil partner or qualifying charity, your pension fund may be subject to IHT.
The IHT liability will generally be settled before beneficiaries receive the remaining pension benefits.
In addition, if you die aged 75 or over, beneficiaries will usually pay income tax when they draw funds from the inherited pension. The amount of tax will depend on their personal circumstances and other income at the time. Worst case is income tax rates on any funds drawn from the inherited pension of 45%.
As a result, the overall tax cost on pension funds can be significant (up to 67%).
The new rules are also expected to increase the administrative burden on executors, personal representatives and pension providers.
2. Other valuable reliefs could be affected
Bringing pension funds into your estate may not only create an IHT charge on the pension itself but could also reduce or eliminate other reliefs and allowances (such as the Residence Nil Rate Band RNRB) that would otherwise be available. This could further increase your IHT liability.
The example below illustrates how this could happen.
Examples
Anna is widowed and aged 80. Her late husband left his entire estate to her, meaning no IHT was payable on his death. Anna intends to leave her estate equally between her two sons. Her assets are:
| Assets | Value (£) |
| Home | 1,000,000 |
| Cash and shares | 600,000 |
| ISAs | 385,000 |
| Pension pot | 900,000 |
| Total | 2,885,000 |
Position under current rules – pension fund is outside the estate for IHT purposes:
| Assets | (£) |
| Home | 1,000,000 |
| Cash and shares | 600,000 |
| ISAs | 385,000 |
| Gross taxable estate | 1,985,000 |
| Residence nil-rate band* | (350,000) |
| Nil-rate band* | (650,000) |
| Chargeable estate | 985,000 |
| IHT 40% | 394,000 |
* Assumes full transfer of Anna’s late husband’s unused Nil Rate Band and Residence Nil Rate Band.
Position from 6 April 2027 – with the pension fund included within the estate:
| Assets | (£) |
| Home | 1,000,000 |
| Cash and shares | 600,000 |
| ISAs | 385,000 |
| Pension pot | 900,000 |
| Gross taxable estate | 2,885,000 |
| Residence nil-rate band** | (nil) |
| Nil-rate band | (650,000) |
| Chargeable estate | 2,235,000 |
| IHT 40% | 894,000 |
**The estate exceeds £2.7 million, resulting in the complete loss of the Residence Nil Rate Band.
In this example, there is an increase in the IHT liability by £500,000. This comprises:
- £360,000 of IHT on the pension fund itself; and
- £140,000 arising from the loss of the RNRB.
What should you do now?
Given the potential impact of these changes, we recommend reviewing your current estate planning arrangements and estimated IHT position.
Understanding the value of your pension funds and how they may affect your overall estate from April 2027 will help identify whether additional planning should be considered.
Once we have assessed your circumstances, we can discuss the options available and whether steps can be taken to reduce the potential tax burden for your family.
If you would like to discuss how these changes may affect you, please get in touch with our Private Clients team.
Please note that this content is not intended to give specific technical advice. It is designed to highlight some of the key issues rather than provide an exhaustive explanation of the topics. Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.
