Pension death benefits have traditionally fallen outside the scope of Inheritance Tax (IHT), but from April 2027 this treatment is set to change, with most unused pension funds and death benefits becoming taxable as part of an individual’s estate.
The changes could have a significant impact on families inheriting pension wealth, with some beneficiaries potentially facing substantially higher combined IHT and Income Tax charges.
As a result, pensions may no longer be as effective from an estate planning perspective, making it increasingly important to review how retirement savings fit within a wider IHT strategy.
Overview of the changes
Currently, pension death benefits can often be passed on tax efficiently, with beneficiaries typically only paying Income Tax where applicable.
From 6 April 2027, this position is set to change significantly. Unused pension funds and certain death benefits will form part of the deceased’s estate for IHT purposes, meaning pension assets will be assessed alongside the rest of the estate and will share the available nil rate band.
Although IHT may apply to the pension fund first, beneficiaries could still face Income Tax when the remaining funds are withdrawn. In some cases, the combined tax burden on inherited pension wealth could therefore be significant.
The government has confirmed that:
- Death-in-service benefits paid through a registered pension scheme will remain exempt from IHT; and
- The existing IHT exemptions for assets passing to a surviving spouse, civil partner or charity will continue to apply.
The changes will create significant additional administrative responsibilities for personal representatives, including:
- Reporting and paying any IHT due on relevant pension funds;
- Gathering information from pension schemes and beneficiaries;
- Allocating the tax attributable to each pension arrangement; and
- Complying with new reporting and communication requirements linked to pension death benefits.
Perhaps one of the most sensitive aspects of the new regime is that responsibility for paying the IHT will initially fall on the personal representatives of the estate, who may then need to recover the relevant amount from pension beneficiaries.
Government estimates suggest around 38,500 estates could face a higher IHT bill as a result of the changes, with affected estates paying an average of £34,000 more in tax when pension assets are included within the estate. However, these figures are based on current behaviour and may reduce if individuals take steps to review their estate and pension planning before the new rules take effect.
As a result, estates involving pensions are likely to become both more complex and more exposed to IHT than under the current rules.
Areas for review
Although the government has confirmed that unused pension funds and certain death benefits will fall within the scope of IHT, some uncertainty remains around the detail while the draft legislation progresses through Parliament. Professional bodies have also raised some technical concerns about how the rules will operate in practice, meaning that any planning at this stage should be approached on the basis that further clarification may still emerge.
However, there are several areas individuals could start reviewing now, particularly where pensions form a significant part of their estate planning.
For many people, the most effective response may be to use pension savings as they were originally intended – to fund retirement rather than accumulate unused funds.
Even where pension funds are not needed for everyday living costs, drawing on them during lifetime may still be beneficial. Withdrawals could be used to support children or grandchildren, fund trusts, or pay into life policies written in trust. Where structured correctly, as normal expenditure out of income, these payments may fall outside the scope of IHT. However, care is needed where a life policy is arranged alongside an annuity on the transferor’s life, as HMRC does not generally regard the associated premium payments as qualifying for the normal expenditure out of income exemption.
Key considerations include:
- Reviewing pension nominations – particularly following divorce, as pension death benefit nominations are not automatically revoked in the same way as wills. Without an update, an ex-spouse could still inherit pension benefits.
- Reviewing wills – bringing pensions into the estate may reduce the nil rate band available for other gifts and legacies, potentially increasing the overall IHT bill by more than originally expected.
- Considering alternative estate planning strategies – including whether pension funds should be distributed or spent during lifetime rather than retained until death.
- Reviewing business property held within pensions – structures involving business premises held within a pension may become significantly less tax efficient. While these arrangements can still offer corporation tax advantages and tax-free growth within the pension, business and agricultural property relief will not apply to assets held inside the pension from an IHT perspective.
- Assessing whether property should be transferred out of the pension – some business owners may wish to explore purchasing property back from the pension and reintegrating it into the business. Any decision will need to consider cashflow, VAT and Stamp Duty Land Tax implications.
- Monitoring exposure to the residence nil rate band taper – from April 2027, pension values will count towards the £2 million taper threshold, potentially affecting estates that previously expected to remain below it.
How M+A Partners can help
From April 2027, pensions may no longer provide the same level of protection from IHT, potentially increasing both the tax exposure and administrative burden for families and personal representatives. Although the legislation is still progressing through Parliament, individuals with significant pension savings should start reviewing their arrangements now.
Our experienced team can help individuals and business owners understand how the proposed changes may affect their wider estate and succession planning. Reviewing arrangements at an early stage may help identify opportunities to mitigate future tax liabilities, ensure existing planning remains effective, and reduce the risk of unintended consequences for beneficiaries.
If you would like to discuss how these changes could affect your circumstances, please speak to your usual M+A Partners’ contact or one of our experts below.
