Navigating the 2027 Inheritance Tax Changes to Pensions

From 6 April 2027, the Inheritance Tax (IHT) treatment of many unused pension funds and pension death benefits will change. Pensions will remain a tax-efficient way to save for retirement, but their role in passing wealth to the next generation may need to be reconsidered.

The change could affect how you draw retirement income, nominate beneficiaries and plan for a potential Inheritance Tax liability. The appropriate response will depend on your circumstances, so the priority is to review your pension alongside your wider estate rather than making an automatic withdrawal decision.

What is changing?

Under the current rules, many unused pension funds can pass to beneficiaries outside the estate for IHT purposes. This has made pensions an attractive way to pass on wealth after death. However, from 6 April 2027, most unused pension funds and pension death benefits will instead be included in the deceased’s estate.

This could affect families with substantial pension savings intended for beneficiaries. Understanding the changes now can help you review your retirement and estate planning before the new rules take effect.

In practical terms, the value of pension wealth within the scope of the new rules may be added to your other assets when calculating the value of your estate. Whether any IHT is payable will then depend on the estate’s total value and the exemptions and allowances available.

This does not mean every pension will automatically create or be subject to an IHT liability.

Why does this matter?

The change could be particularly important for people who have left some or all of their pension savings invested rather than drawing on them to fund retirement.

Previously, there could be a tax advantage in using other savings and investments first while leaving pension funds untouched for beneficiaries. That strategy may now become less attractive because unused pension wealth could increase the taxable value of the estate.

For affected families, the additional tax could reduce the amount passed to children, grandchildren or other beneficiaries.

How will the tax be paid?

The personal representatives of the deceased’s estate will generally be responsible for reporting and paying any IHT due on unused pension funds and relevant death benefits. This differs from an earlier proposal that would have placed responsibility on pension scheme administrators. This could create practical difficulties where much of an estate’s value is held in a pension and there is not enough cash elsewhere to pay the tax. To help, personal representatives will, in certain circumstances, be able to direct pension administrators to withhold part of the pension benefits and pay the relevant IHT to HMRC. This makes it important to consider not only the total value of your estate but also where your wealth is held and how easily it can be accessed.

Are all pension benefits affected?

No. There are important exclusions.

Death-in-service benefits payable from a registered pension scheme will remain outside the estate for IHT purposes under the new rules. Certain dependant’s pensions from defined benefit and collective money purchase arrangements are also excluded.

Existing IHT exemptions will also remain relevant. For example, pension benefits passing to a surviving spouse or civil partner may qualify for the spouse or civil partner exemption - subject to the usual conditions.

What should you consider now?

The changes do not mean you should automatically withdraw money from your pension before April 2027.

Taking money out solely to avoid a potential IHT charge could create other tax and financial consequences. Withdrawals may be subject to income tax, and taking too much from your pension could reduce the funds available to support your retirement.

Money withdrawn but not spent may also become part of your estate in another form.

Consider:

1. How much is your pension worth?

Review your current pension values and consider how they may grow before April 2027 and beyond.

2. What other assets do you own?

Consider your pension alongside property, investments, savings and other assets when assessing potential IHT exposure.

3. Who would receive your pension?

Check your beneficiary nominations with your pension provider. Keeping these details up to date remains an important part of estate planning.

4. How much income do you need?

Your retirement income needs should remain the starting point for pension decisions. Tax planning should support your financial objectives rather than dictate them.

5. Is there enough liquidity in your estate?

If IHT becomes payable, your family may need access to cash to settle the cost. This should form part of your wider estate planning.

6. Annuities

Changing capital into an income can reduce the value of your estate but is this the right solution for you?

The 2027 reforms make the relationship between pension, retirement and estate planning more complex. For some people, drawing more from a pension during retirement may be appropriate. For others, retaining pension wealth could still be the right approach. The answer will depend on factors including your age, income needs, health, other assets, beneficiaries and overall tax position.

A strategy that works for one household could create unnecessary tax or reduce financial security for another. The key is to consider your pension as part of your wider financial plan rather than in isolation.

Being prepared for change

The new rules have been legislated for, with further guidance and supporting materials being developed ahead of implementation. HMRC has published technical information explaining how unused pension funds will be identified, valued and dealt with for IHT purposes.

Reviewing your pension and estate planning before the rules take effect can give you time to consider your options carefully. You do not need to make decisions simply because the rules are changing. However, understanding how the reforms could affect you can help you make informed choices based on your long-term financial objectives.

If you have significant pension savings or are concerned about the potential impact of the 2027 IHT changes, speaking to a regulated financial adviser and, where appropriate, a tax or estate-planning specialist can help you understand your options. 

Please note that this article does not constitute financial advice, and you should always consider taking professional advice before making financial decisions. Indeed, it’s important to consider seeking professional advice to explore the best options for your needs. Your Dentons Adviser can help you work out the right option for your personal circumstances.