What Is Pension IHT Double Taxation?
Double taxation on inherited pensions arises when the same pension funds are subject to both inheritance tax (IHT) and income tax. Currently, most pension death benefits sit outside your estate for IHT purposes, so this is not a concern. However, the government announced in the Autumn Budget 2024 that from April 2027, unused pension funds will be brought within the scope of IHT.
This creates a potential problem: if your pension is included in your estate and IHT at 40% is charged, your beneficiaries may then face income tax (at up to 45%) when they draw income from the inherited pension pot. The combined effective tax rate could theoretically reach 64% or more, dramatically reducing what your loved ones actually receive.
How the Current Rules Work (Pre-April 2027)
Under the current rules, pension death benefits enjoy a highly favourable tax position:
- Outside the estate — pension funds are not included in your estate for IHT purposes, so no 40% IHT is payable regardless of the size of your pension pot
- Death before 75 — beneficiaries receive DC pension funds completely free of income tax (whether taken as a lump sum or drawdown)
- Death at 75 or over — beneficiaries pay income tax at their marginal rate on withdrawals, but there is no IHT
This has made pensions one of the most powerful inheritance planning tools available. Many financial advisers recommend spending other assets first (ISAs, savings, property equity) and preserving pension funds specifically because of their IHT-exempt status.
What Changes from April 2027
From 6 April 2027, the value of your unused pension funds at death will be included in your estate for IHT purposes. This means:
- Your pension pot is added to the value of your other assets (property, savings, investments) when calculating your total estate
- If your total estate exceeds the available nil-rate bands, IHT at 40% will be charged on the excess
- The pension scheme administrator, rather than the estate executor, will be responsible for paying the IHT attributable to the pension
The Nil-Rate Bands
| Allowance | Amount | Notes |
|---|---|---|
| Nil-rate band (NRB) | £325,000 | Available to everyone; frozen until at least April 2030 |
| Residence nil-rate band (RNRB) | £175,000 | Available when passing a home to direct descendants; tapers for estates over £2m |
| Transferable NRB (spouse) | £325,000 | Unused NRB can transfer to surviving spouse |
| Transferable RNRB (spouse) | £175,000 | Unused RNRB can transfer to surviving spouse |
| Maximum for a couple | £1,000,000 | Combined maximum before IHT applies (if RNRB conditions met) |
The Double Taxation Problem Explained
The core issue is that pension funds could be taxed twice: once through IHT when you die, and again through income tax when your beneficiaries withdraw the money. Here is how it works in practice:
Example: The Impact on a £500,000 Pension
Consider a scenario where a widow dies at age 80 with a £500,000 DC pension and £600,000 in other assets (total estate: £1,100,000). She has one child as her sole beneficiary.
| Calculation Step | Amount |
|---|---|
| Total estate (including pension) | £1,100,000 |
| Less: NRB + RNRB (£325,000 + £175,000) | −£500,000 |
| Taxable estate | £600,000 |
| IHT at 40% | £240,000 |
| Pension pot after IHT (proportionate share) | ~£391,000 |
| Income tax on drawdown (at 40% higher rate) | ~£156,000 |
| Net amount received by beneficiary from pension | ~£235,000 |
| Effective combined tax rate on pension | ~53% |
In this example, the beneficiary loses over half the pension to combined taxation. For higher or additional rate taxpayers, the effective rate could be even higher.
Who Is Most at Risk?
The double taxation problem will not affect everyone equally. You are most at risk if:
- You have a large untouched DC pension — the bigger the pension pot, the greater the potential IHT and income tax liability
- Your total estate (including pension) exceeds the nil-rate bands — estates within the NRB/RNRB thresholds will not face IHT
- You are single or widowed — you cannot benefit from the spousal exemption or transferable nil-rate bands
- Your beneficiaries are higher or additional rate taxpayers — the income tax element of double taxation hits harder at higher marginal rates
- You die at 75 or over — death before 75 may still allow tax-free drawdown (subject to the LSDBA), partially mitigating the double taxation
Possible Government Relief Mechanisms
The government has signalled that it recognises the double taxation issue and intends to provide some form of mitigation. Options that have been discussed include:
- Income tax credit — beneficiaries could receive a credit against their income tax bill for the IHT already paid on the pension, similar to the existing relief for successive charges
- Exclusion of drawdown from IHT — pensions taken as drawdown income (rather than lump sums) could be excluded from the IHT calculation
- Reduced IHT rate on pensions — a lower IHT rate could apply specifically to pension assets to account for the future income tax liability
- Top-slicing relief — the income tax on inherited pensions could be spread over multiple years to prevent beneficiaries being pushed into higher tax brackets
Until the government confirms the final approach, it is difficult to plan with certainty. However, there are strategies you can adopt now to reduce your exposure.
Strategies to Minimise Double Taxation
1. Draw Down Your Pension and Gift the Proceeds
By withdrawing from your pension during your lifetime and gifting the cash to your intended beneficiaries, you can reduce the value of your pension (and therefore your estate) over time. Gifts made more than seven years before your death fall outside your estate entirely for IHT purposes.
The trade-off is that you will pay income tax on the withdrawals at your marginal rate, and you need to ensure you do not need the funds for your own retirement.
2. Spend Your Pension First, Preserve Other Assets
This reverses the traditional advice. If pensions are going to be subject to IHT anyway, it may make sense to spend your pension income first and preserve assets that qualify for other IHT reliefs — such as business property relief (BPR) or agricultural property relief (APR) at 100%.
3. Use Spousal Exemptions
Assets passing to a spouse or civil partner are exempt from IHT. If you nominate your spouse as primary beneficiary of your pension, no IHT will be payable on the pension at your death. Your spouse can then plan how to pass the funds to the next generation in the most tax-efficient manner.
4. Fund Life Insurance Within a Trust
Rather than relying on your pension as a legacy, you could use pension income to fund a life insurance policy written in trust. The insurance proceeds would be paid directly to your beneficiaries outside your estate, providing a tax-free lump sum to offset any IHT liability on your pension.
5. Consider Charitable Giving
If you leave 10% or more of your net estate to charity, the IHT rate on the rest of your estate drops from 40% to 36%. Nominating a charity as a partial beneficiary of your pension could reduce the overall IHT bill while supporting a cause you care about.
DB Pensions and Double Taxation
The double taxation risk affects DC and DB pensions differently. For DB pensions:
- Dependant's pensions are ongoing income payments, not a lump sum. The government has indicated these may be valued differently for IHT purposes, potentially using an actuarial calculation of the future income stream
- Lump sum death benefits from DB schemes (such as death-in-service payments) will be included in the estate, similar to DC pensions
- Spouse's pensions may benefit from the spousal exemption, meaning no IHT is payable on benefits passing to a surviving spouse
The practical impact on DB pension holders may therefore be less severe than for those with large DC pots, though the full details will depend on the final legislation.
Timeline and What to Do Now
- Before April 2027 — review your estate plan and pension nominations with a financial adviser
- Model scenarios — ask your adviser to calculate the potential IHT and income tax liabilities under the new rules
- Consider drawdown strategies — if appropriate, begin drawing pension income and gifting to beneficiaries to start the seven-year clock
- Update your will and nominations — ensure your will and pension nomination forms are aligned and reflect the most tax-efficient approach
- Monitor government announcements — the detailed rules may change before April 2027, and the relief mechanism against double taxation will be crucial
Next Steps
The pension IHT changes represent a significant shift that requires careful planning. Do not wait until April 2027 to act — some strategies (such as gifting) require time to be effective. Speak to an FCA-regulated financial adviser who can model your specific circumstances and recommend appropriate actions.
For related guidance, see our articles on pension death benefits, leaving your pension to grandchildren, and the lump sum and death benefit allowance.