Pensions and Inheritance Tax from 2027: Complete Guide

One of the most significant tax changes in a generation is coming in April 2027: for the first time, unused pension pots will be included in your estate for inheritance tax (IHT) purposes. This change fundamentally alters the role of pensions in estate planning and could affect hundreds of thousands of families. Here is everything you need to know.

How Pensions Are Currently Treated for IHT

Under the current rules (up to April 2027), defined contribution pension pots sit outside your estate for inheritance tax purposes. This makes pensions one of the most tax-efficient vehicles for passing wealth to the next generation:

• Death before age 75: Beneficiaries can inherit the pension pot entirely tax-free, whether taken as a lump sum or as drawdown income.
• Death at age 75 or over: Beneficiaries pay income tax at their marginal rate when they withdraw from the inherited pension, but no inheritance tax is due on the pot itself.

This favourable treatment has led many financial advisers to recommend spending other assets first in retirement and preserving pension wealth as long as possible. Some retirees have deliberately avoided drawing their pensions, using ISAs and other savings instead, to maximise the IHT-free pension they can pass on.

What Changes From April 2027

From 6 April 2027, unused defined contribution pension funds will be brought into the scope of inheritance tax. Here is how it will work:

• When you die, the value of your remaining pension pot will be added to your estate for IHT purposes.
• The standard IHT nil-rate band (£325,000) and residence nil-rate band (£175,000, where applicable) will still apply to your total estate, including the pension.
• Any estate value above the nil-rate bands will be taxed at 40%.
• Beneficiaries will still pay income tax on pension withdrawals as before (tax-free if death is before 75, income tax if after 75), but there will also be IHT on the pot value itself.
• The pension scheme administrator will be responsible for paying the IHT attributable to the pension, with the charge recovered from the pension fund before distribution to beneficiaries.

Who Is Affected

This change mainly affects people with larger estates where the pension pot pushes the total value above the IHT threshold. Consider these scenarios:

Scenario 1: Moderate Estate

A married couple owns a home worth £400,000, has £100,000 in savings, and a combined pension pot of £200,000. Their total estate is £700,000. With the nil-rate band (£325,000) and residence nil-rate band (£175,000) for each spouse, they have a combined threshold of £1,000,000. No IHT is due. For this couple, the pension change has no impact.

Scenario 2: Larger Estate

A widow owns a home worth £600,000, has £200,000 in ISAs and investments, and an untouched pension pot of £500,000. Her total estate is £1,300,000. Using both her own and her late husband's transferred nil-rate bands, her IHT threshold is £1,000,000. Under current rules, only the £800,000 non-pension estate is counted, meaning no IHT. Under the new rules, the £500,000 pension is included, bringing the estate to £1,300,000 and creating an IHT bill of £120,000 (40% of £300,000).

Planning Strategies

If you are likely to be affected, there are several strategies worth considering before April 2027:

1. Draw Down Your Pension Earlier

If your estate is likely to exceed the IHT threshold, it may make sense to start drawing from your pension rather than preserving it. You will pay income tax on the withdrawals, but the money will leave your estate. You could use the withdrawals to fund gifts, which become IHT-free after seven years, or to contribute to your grandchildren's Junior ISAs.

2. Spend the Pension, Preserve the ISA

The traditional advice was to spend ISAs first and preserve pensions. From 2027, this logic reverses for larger estates. ISAs are already within the estate for IHT, so spending down the pension (which would add to IHT) and keeping the ISA (which is already counted) can be more efficient.

3. Consider Life Insurance

A whole-of-life insurance policy written in trust can provide funds to cover the expected IHT bill without the proceeds being part of your estate. This is particularly useful if you want to keep your pension intact for beneficiaries but offset the tax charge.

4. Make Gifts During Your Lifetime

Withdrawing pension funds and making gifts can reduce your estate over time. Potentially exempt transfers become fully IHT-free after seven years. You can also use the annual gift exemption (£3,000 per year) and small gift exemption (£250 per person) without starting the seven-year clock.

5. Review Your Pension Contributions

If you are still working and making pension contributions primarily for IHT planning rather than retirement income, you may want to reconsider. The tax relief on contributions is still valuable, but the IHT benefit has been removed. Use our Pension Calculator to model how different contribution levels affect your retirement income and overall tax position.

What About Defined Benefit Pensions?

The government has confirmed that defined benefit (final salary) pensions will also be brought into scope, though the valuation method is still being consulted on. A lump sum death benefit from a DB scheme will likely be included at face value, while ongoing spouse's pensions may be valued using actuarial factors. Further guidance is expected later in 2026.

Take Action Now

The April 2027 change is still over a year away, giving you time to plan. Start by understanding the size of your estate including your pension, then consider whether any of the strategies above could reduce your family's potential IHT bill. Most importantly, seek professional advice: estate planning in this area is complex and the right approach depends entirely on your individual circumstances.

Use our Pension Calculator to model your retirement income and see how drawing down your pension at different rates could affect your long-term finances.