The UK government’s decision to bring most unused pension funds within the scope of inheritance tax (IHT) from April 2027 marks one of the most significant changes to estate planning in recent years. For decades, pensions have been a highly tax-efficient way to pass on wealth, but this is set to change, with wide-reaching implications for individuals, families, and financial advisers alike.
What’s Changing?
Currently, most defined contribution (DC) pensions—where you build up a pot of money to fund your retirement—are not included in your estate for IHT purposes. This means that, upon death, beneficiaries can usually inherit unused pension funds free from inheritance tax, although income tax may still apply depending on the age at death.
From 6 April 2027, this will change. Unused pension funds and most death benefits will be included in the value of a person’s estate for IHT purposes. If the total estate, including pension wealth, exceeds the IHT threshold (currently £325,000, or up to £500,000 if a home is left to direct descendants), the excess will be taxed at 40%. The government’s stated aim is to prevent pensions from being used primarily as a vehicle for intergenerational wealth transfer, rather than for funding retirement.
Who Will Be Affected?
While the majority of estates will still not pay IHT—HMRC estimates that out of around 213,000 estates with inheritable pension wealth in 2027-28, about 10,500 will have a new IHT liability—the average additional bill is expected to be around £34,000. Those most affected will be individuals with substantial pension pots who do not need to draw on them in retirement and had planned to pass them on to children or grandchildren.
Importantly, the usual IHT exemptions will still apply. Anything left to a surviving spouse or civil partner remains exempt, and unused allowances can be transferred, meaning up to £1 million could potentially be passed on tax-free on second death.
How Will It Work?
The responsibility for reporting and paying IHT on unused pension funds will fall to the personal representatives (PRs) of the deceased’s estate, not the pension scheme administrators. This change follows industry feedback that administrators would not have full visibility over the deceased’s total estate, potentially leading to overpayments or delays.
PRs will need to work with pension providers to obtain valuations and ensure the correct amount of tax is paid. This could add complexity and administrative burden to the probate process, especially where multiple pension pots or beneficiaries are involved.
Some types of pension benefits will remain outside the scope of IHT, including death-in-service benefits and dependants’ scheme pensions.
Why Is This Happening?
The government argues that recent pension freedoms and the abolition of the lifetime allowance have led to pensions being used as a tax planning tool, rather than for retirement income. By including pensions in the IHT net, the government aims to create a fairer and less distortive tax system.
What Should You Do Now?
With these changes looming, estate planning is more important than ever. Here are some practical steps:
-Review your will and pension nominations to ensure they reflect your wishes and are tax-efficient.
– Calculate your total estate value, including pensions, property, and other assets.
– Consider gifting strategies: Gifts made more than seven years before death are usually exempt from IHT, but careful record-keeping is essential.
– Seek professional advice: The interaction between pensions, IHT, and other allowances can be complex, and tailored advice is crucial.
Conclusion
The inclusion of pensions in the IHT calculation from April 2027 is a game-changer for many families. While most estates will remain unaffected, those with significant pension wealth should act now to review their estate plans and avoid unexpected tax bills. As always, early planning and expert advice are key to navigating these changes successfully.
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