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By Introduction
For decades, pensions were one of the most powerful tools in UK estate planning — largely because unused pension funds sat outside your estate for Inheritance Tax (IHT) purposes. That is about to change.
The October 2024 Budget announced that from April 2027, unused pension funds and death benefits will be brought within the scope of IHT. For many families, this is the single most significant change to estate planning in a generation. If you have a pension, this affects you — and the time to plan is now, not in 2027.
How Pensions and IHT Currently Work
Under current rules, defined contribution pension funds — including SIPPs and workplace pensions — do not form part of your estate for IHT purposes when you die. This means the full value of your pension pot can pass to your nominated beneficiaries free of the 40% IHT charge that applies to estates above the nil-rate band threshold.
This made pensions an exceptionally tax-efficient vehicle for wealth transfer. Many financial advisers and accountants have for years recommended drawing on other assets in retirement first — ISAs, savings, investment accounts — and preserving pension funds specifically because they sat outside the IHT net.
That strategy is about to become significantly less effective.
What Changes From April 2027
From April 6, 2027, unused pension funds and lump sum death benefits payable from pension schemes will be included in the value of your estate for IHT purposes. The personal representative of your estate will be responsible for reporting the pension value to HMRC and for any resulting IHT liability.
The government has confirmed that pension scheme administrators will be required to pay any IHT attributable to pension funds directly to HMRC — meaning the tax will be deducted from the pension before it reaches your beneficiaries. This removes the previous ability to rely on beneficiaries paying the tax out of their own resources.
Key point: The change applies to defined contribution pensions. Most defined benefit (final salary) pension schemes do not accumulate a residual fund in the same way, so the practical impact is smaller for those members — though lump sum death benefits from defined benefit schemes will still be affected.
Who Is Most Affected?
The change will have the greatest impact on:
⦁ Individuals who have deliberately preserved pension funds as a vehicle for passing wealth to children or grandchildren
⦁ Higher earners who have accumulated large pension pots and do not expect to draw them down fully in retirement
⦁ Business owners who use SIPPs as part of their overall retirement and succession planning
⦁ Couples where one partner has a significantly larger pension than the other
For those with smaller pensions that, combined with other assets, keep the total estate below the IHT threshold (currently £325,000 per person, or up to £1 million for couples with the residence nil-rate band), the change may have no practical effect at all.
The Interaction with the Nil-Rate Band
It is important to understand how pension assets will interact with the existing IHT thresholds. The nil-rate band (£325,000 per person), the residence nil-rate band (£175,000, subject to conditions), and any transferred nil-rate band from a deceased spouse or civil partner will all still apply to the combined estate — including the newly added pension assets.
For a married couple both with moderate estates, the combined threshold before IHT applies could be as high as £1 million. Pension assets would only attract IHT to the extent the total estate — including the pension — exceeds this threshold.
For those with larger estates, however, the pension change represents a genuine and material increase in IHT exposure.
Planning Strategies to Consider Now
The announcement has given individuals and advisers roughly two years to adapt their planning. Options worth discussing with your accountant and financial adviser include:
- Review Your Drawdown Strategy
If you have been deliberately drawing from non-pension assets to preserve your pension fund, it may now be worth reconsidering the order in which you draw down. Taking more income from your pension during your lifetime reduces the value that will be subject to IHT — and your personal income tax rate in retirement may be lower than the 40% IHT rate your beneficiaries would otherwise face. - Consider Gifting Now
Lifetime gifts are potentially exempt from IHT if you survive seven years after making them. Gifts from pension income drawn now — to children, grandchildren, or a trust — could reduce your estate over time. The annual gifting exemption (£3,000 per year) remains available and is stackable with gifts out of surplus income. - Pension Nominations — Review Your Expression of Wishes
Your pension nomination form (expression of wishes) tells the pension trustees who you want to receive your pension fund on death. Review this in light of the new rules. In some cases, directing pension assets to a surviving spouse may still be advantageous — transfers between spouses remain exempt from IHT. - Life Insurance in Trust
A life insurance policy written in trust sits outside your estate and can be used to provide a lump sum to cover an IHT liability on death, without itself attracting IHT. The cost of whole-of-life cover increases with age, so acting sooner is cheaper.
What You Should Do Before April 2027
The most important first step is to obtain a current valuation of your pension fund and model what your estate looks like with it included. Many people have never done this calculation because it was irrelevant under the old rules.
Once you have a clear picture of your estate’s total value — including pensions — you and your accountant can identify whether you have an IHT exposure and, if so, which planning strategies are most appropriate for your circumstances.
Conclusion
The Budget’s pension and IHT changes are a significant shift in the landscape of estate planning for UK individuals. Acting early gives you the most options. Waiting until 2027 significantly restricts what can be done. If you have a pension fund and have not yet reviewed your estate plan in light of these changes, now is the right time to do so. Our team can help you model the impact and put a sensible, tax-efficient plan in place.
