Pensions are set to be drawn into the Inheritance Tax (IHT) net from April 2027, in a major change to the current rules, which means you need to know what to expect so you can prepare accordingly.
Currently, pensions are often outside your estate for Inheritance Tax (IHT) purposes, meaning they can usually be passed on to beneficiaries without being caught in the IHT net. However, this depends on how the pension is structured.
From 6 April 2027, this is set to change, and your pension may be subject to IHT if the value of your estate is high enough. From this date, most unused pension funds and death benefits are expected to be included when calculating the value of your estate for IHT purposes.
The beneficiary who receives your pension may also face an income tax charge on any income they draw from it, depending on your age at death.
Pensions passed to a spouse or civil partner may still benefit from the usual IHT spouse exemption. However, any other beneficiary may face IHT on the pension that is passed on when you die, depending on the value of your estate.
What changes can we expect if passing on a pension fund?
The biggest change is that any pension passed onto a beneficiary other than a spouse or civil partner may be subject to IHT at 40% if the total value of your estate breaches the IHT threshold. This is currently made up of a nil rate band of £325,000, with an additional £175,000 residence nil rate band, which can be applied if you pass your home on to direct descendants. This means you have up to £500,000 each, if you have children that you can pass your family home onto.
If one spouse or civil partner dies before the other, and doesn’t use all their IHT allowances, then the surviving spouse or civil partner can use the remaining amount. This gives a total of up to £1m before IHT is applied, depending on the remaining allowance available.
Once these limits are exceeded, any amount above this level is subject to IHT at 40%. Given the average UK house price in January 2026 was £300,077, according to data from Halifax, and that the pension pot will be included in the estate from April 2027 onwards, it will be easier to breach. This means more estates are likely to be affected.
What happens to any death-in-service benefits?
Death-in-service benefits, which are paid from the pension scheme if you die while still working, will be outside of IHT. But any other death benefits paid, such as a lump sum from the pension fund, or any remaining pension to be passed on, will generally be included in the estate for IHT.
If you die before you reach 75, then anyone who you pass your remaining pension pot to, can usually draw money from the pension without income tax, but it may still be subject to IHT, unless it is passed directly to a spouse or civil partner or your overall estate is below the threshold.
If you die after age 75, then as well as IHT, any income drawn from the pension by the beneficiary will also be subject to income tax. If it is passed to your spouse or civil partner, it won’t be subject to IHT, but he or she will still pay income tax on withdrawals in this case.
How can you reduce the impact of rule changes next year?
The best way to reduce the impact of these changes when you’re passing on your pension fund, may be to review whether drawing down pension funds and making gifts is appropriate. But there are rules you need to consider before you do this.
For example, you are allowed to make regular gifts of any amount of money to someone, providing it doesn’t affect your standard of living. You can also make a larger, one-off gift, but you must survive the gift by seven years for it to be fully outside of the IHT net. This is known as a Potentially Exempt Transfer. Taper relief may reduce the IHT payable if the death occurs between three and seven years after the gift is made, until it is excluded from IHT entirely.
You can also gift up to £3,000 a year in total without it being subject to IHT, even if your estate exceeds the threshold on death. If you missed gifting £3,000 in one year, you could double up in the next year. But this allowance can only be carried forward for one year.
Outside of this, you can gift up to £250 per person per year to as many people as you want, but you can’t combine this with the £3,000 gift. If you have a child getting married, you can gift up to £5,000 without the spectre of IHT, or £2,500 for a grandchild, or £1,000 to anyone else.
These rules can be helpful, but any decisions should consider your overall financial position and ability to maintain your standard of living. It is always best to take advice before you make any of these decisions, to ensure you’re doing the right thing and not breaching any rules or creating problems for those left behind.
Contact us
If you would like to find out how these rules may affect you from next year, and how to deal with them effectively, then please get in touch with us and we will explain what you need to know.
Disclaimer
This article is for general information only and reflects our understanding of current HMRC and GOV.UK guidance at the date of publication. It does not constitute financial, tax or legal advice. The tax treatment of pensions and estates depends on individual circumstances and may change. You should seek professional advice before taking any action.