Pensions and inheritance tax: What the new rules could mean for your estate 

In her 2024 Autumn Budget, Chancellor Rachel Reeves announced the government’s plans to include most unused pensions in a person’s estate when calculating inheritance tax (IHT).

This landmark reform will take effect from 6 April 2027, and it could significantly increase IHT liabilities for many families. The government estimates that 10,500 estates will face an IHT bill when they wouldn’t have done previously, while 38,500 estates are likely to pay more.

Worryingly, research by Standard Life reveals that 89% of UK adults have little or no awareness of the upcoming changes, putting their loved ones at risk of facing an unexpected tax bill.

Keep reading to find out how inheritance tax on pensions is changing and discover three practical steps you can take now to prepare.

How inheritance tax on pensions currently works

When someone dies, IHT might need to be paid on the estate (their money, property and possessions) they pass on if its value exceeds certain thresholds. Where IHT applies, anything above the thresholds is normally charged at 40%.

However, under the current rules, most unused pension funds and lump-sum death benefits aren’t considered part of a person’s estate for IHT purposes. This means they can usually be passed on without the beneficiary facing an IHT charge.

That’s why pensions are often used as an effective estate planning tool for passing wealth to the next generation tax-efficiently.

What’s changing from April 2027

From 6 April 2027, most unused pension funds and death benefits will be included in your estate for IHT purposes.

This could push the total value of your estate over – or further over – the IHT thresholds (the amount you can pass on without an IHT charge). As such, your beneficiaries might lose a greater portion of their inheritance to tax.

Some pensions are exempt from the new rules, such as defined benefit or “final salary” pensions and death in service benefits from employer Group Life schemes. Additionally, transfers to a surviving spouse or civil partner remain exempt from IHT.

It’s worth speaking to your financial planner, who can explain how the upcoming reforms are likely to affect your pensions and help you adjust your estate plan accordingly.

3 practical ways to protect your pension from inheritance tax

Here are three practical steps you could take to limit the impact of the IHT pensions reforms on your estate plan.

1. Consider spending your pension earlier in retirement

Many retirees choose to spend their ISAs and other assets first and preserve their pension wealth to pass on tax-efficiently to their family. Once the exemption for IHT on pensions ends, this logic will no longer apply.

Moreover, the changes might put your pensions at risk of being taxed twice after your death. This ‘double taxation’ could happen if your pensions become subject to IHT and the beneficiary is charged income tax on withdrawals (this only applies if the pension holder dies after age 75).

As such, you might want to consider spending your pension earlier in retirement rather than leaving it exposed to IHT.

2. Gift wealth strategically during your lifetime

One of the simplest and most rewarding ways to protect your pension wealth from IHT is to gift more of it during your lifetime.

There are various allowances and exemptions you could use to give money away without incurring IHT. For example, each tax year you can give gifts of up to £3,000 without them being added to the value of your estate; this is known as your ‘annual exemption’.

You could also gift a potentially unlimited amount without triggering an IHT charge by making regular payments out of your income, provided you’re still able to maintain your standard of living.

In addition to tax efficiency, lifetime gifting offers the advantage of letting you see your loved ones benefit from your wealth.

However, the rules are complex, so it’s important to speak with your financial planner, who can ensure you make effective and appropriate use of available allowances.

3. Use your pension wealth to buy life insurance

If the new rules are likely to bring your estate within the scope of IHT or result in a larger tax bill, preparing for these costs could protect your loved ones from unnecessary expense and stress.

As such, you might want to consider using your pension wealth to buy life insurance. This could provide your beneficiaries with a lump sum that they can use to pay an IHT bill without needing to sell any assets.

Moreover, if you put your life insurance policy in a trust, it will sit outside your estate for IHT purposes. This means any payout goes directly to your beneficiaries, who will receive the full amount.

In contrast, if your insurance isn’t in a trust, the payout will usually be included in IHT calculations, and your family will need to wait for probate to be completed before receiving any money.

We can help you review and adjust your estate plan to keep it as tax-efficient as possible

If you’re feeling anxious or confused about the upcoming changes to IHT on pensions, we can help.

Your financial planner can explore how the new rules might affect your estate and identify appropriate adjustments you could make to ensure your wealth is passed on as tax-efficiently as possible.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning or tax planning.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.