Pension Inheritance Tax Changes 2027: What You Need to Know

What Is Changing in April 2027?

The Chancellor announced in the Autumn Budget 2024 that from 6 April 2027, unused pension funds and death benefits will be brought within the scope of inheritance tax (IHT). This represents the most significant change to pension taxation since the pension freedoms of 2015 and will have far-reaching consequences for estate planning across the UK.

Currently, pensions sit entirely outside your estate for IHT purposes. This means that no matter how large your pension pot is, it is not counted when calculating whether your estate exceeds the IHT threshold. From April 2027, that exemption ends. The value of your defined contribution pension, any death benefits payable from a defined benefit scheme, and certain other pension arrangements will all form part of your taxable estate.

How Pensions Are Currently Treated for IHT

Under the current rules (in force until 5 April 2027), pensions enjoy a uniquely favourable IHT position:

• Unused DC pension funds are not part of your estate for IHT purposes
• DB pension death benefits (dependant's pensions and lump sums) are also outside the IHT net
• If you die before age 75, your DC pension can be passed on completely tax-free to anyone you nominate
• If you die at 75 or over, beneficiaries pay income tax on withdrawals but no IHT
• There is no limit on the amount that can pass IHT-free through a pension

This favourable treatment has made pensions one of the most powerful estate planning tools available. Many people have adopted a strategy of spending other assets first in retirement and leaving their pension untouched to pass on tax-efficiently. That strategy will need revisiting after April 2027.

The New Rules from April 2027

Under the proposed changes, the following will apply:

What Counts Towards Your Estate

• DC pension pots — the full value of any uncrystallised and crystallised funds in your DC pension, SIPP, or personal pension at the date of death
• DB pension death benefits — the actuarial value of any lump sum death benefits and dependant's pensions payable
• Pension funds in drawdown — any remaining funds in a flexi-access drawdown arrangement
• Death-in-service benefits — lump sum death-in-service payments from occupational schemes

IHT Thresholds and Rates

IHT is charged at 40% on any amount above the available nil-rate bands. For estates valued above £2 million, the residence nil-rate band is tapered at £1 for every £2 above this threshold, which means adding a large pension pot to your estate could eliminate the RNRB entirely.

The Double Taxation Problem

One of the most controversial aspects of the new rules is the risk of double taxation. Under the proposed regime, pension funds could be subject to both inheritance tax and income tax:

In the worst-case scenario, a beneficiary could face an effective tax rate of over 60% on inherited pension funds. The government has acknowledged this issue and stated that it will introduce measures to prevent or mitigate double taxation, but at the time of writing, the detailed mechanism has not been published.

Who Is Most Affected?

The changes will affect different people in different ways. Those most significantly impacted include:

People Using Pensions as IHT Planning Tools

If you have been deliberately leaving your pension untouched and spending other assets first — a common and entirely legitimate strategy under the current rules — you will need to reconsider. The entire basis of this approach was that pensions sit outside IHT. Once that changes, the strategy no longer works as intended.

Those with Large DC Pension Pots

If your DC pension is worth £500,000 or more, the addition of this sum to your estate could push you well above the IHT thresholds and potentially eliminate your residence nil-rate band. The larger your pension, the greater the potential IHT exposure.

Single Individuals Without a Spouse

Married couples and civil partners benefit from the spouse exemption, which means transfers between spouses are always IHT-free. If you are single, divorced, or widowed, your entire pension forms part of your estate without any spouse exemption to soften the impact.

Those Who Have Already Taken Tax-Free Cash

If you have taken your 25% tax-free lump sum and invested it outside your pension, those funds are already in your estate for IHT. The remaining 75% in your pension was previously outside IHT but will be brought in from April 2027. This means your total IHT exposure is now higher than under either the old or new rules alone.

Planning Strategies Before April 2027

While the specific actions you take should be guided by professional financial advice tailored to your circumstances, the following strategies are being discussed and considered:

1. Review Your Overall Estate Plan

Start by understanding the total value of your estate, including your pension. This means adding up property, savings, investments, life insurance (if not in trust), and now your pension. Compare this against your available IHT allowances to see whether you have an IHT liability.

2. Consider Spending Pension First

The old strategy of spending other assets and preserving your pension may need to be reversed. If your pension is your largest asset, it may be more tax-efficient to draw from your pension in retirement and use the proceeds to fund your lifestyle, make gifts, or invest in IHT-efficient arrangements.

3. Make Lifetime Gifts

You can withdraw funds from your pension (paying income tax) and gift the money to your beneficiaries. If you survive seven years after the gift, it falls outside your estate entirely. This strategy works best if you have time and sufficient other income to maintain your lifestyle while giving away pension withdrawals.

4. Use Your Tax-Free Lump Sum Strategically

Your 25% tax-free lump sum could be withdrawn and placed into a trust, gifted to family, or used to fund life insurance premiums written in trust. Each of these approaches can help reduce your overall IHT liability.

5. Life Insurance in Trust

If your estate will exceed the IHT threshold, a life insurance policy written in trust can provide funds to pay the IHT bill without your beneficiaries having to sell assets. The policy proceeds go directly to the trust and are not part of your estate.

Spouse and Civil Partner Exemption

One critical planning point: transfers between spouses and civil partners remain exempt from IHT. This means:

• If you leave your pension to your spouse, no IHT is due on that transfer
• Your spouse can also inherit your unused nil-rate band and residence nil-rate band
• The IHT liability is deferred until the second spouse dies
• A married couple can potentially pass up to £1 million IHT-free (using both sets of NRB and RNRB)

If you are in a couple, the most tax-efficient approach is often to leave your pension to your spouse first, allowing the combined allowances to shelter more of the estate when the surviving spouse eventually dies. However, this depends on the overall size of the combined estate and the specific circumstances of each partner.

Impact on Different Pension Types

Defined Contribution (DC) Pensions

DC pensions will be most directly affected because the entire remaining fund value at death is easy to quantify and will be added to the estate. This includes SIPPs, personal pensions, workplace DC pensions, and stakeholder pensions. The full value of any undrawn and drawn-down funds will count.

Defined Benefit (DB) Pensions

DB pensions present a more complex valuation challenge. The government will need to establish how to value future dependant's pension payments and lump sum death benefits for IHT purposes. An actuarial methodology will likely be required, and the details are still being finalised. Read our guide on DC vs DB death benefits for more on how the two types compare.

State Pension

The state pension is not expected to be affected by the IHT changes. State pension entitlements end on death (apart from certain bereavement-related payments) and do not form part of your estate.

What We Do Not Yet Know

Several important details remain to be confirmed by the government:

• Double taxation relief mechanism — how exactly will the government prevent pension funds being taxed twice?
• DB pension valuation — what actuarial method will be used to value DB death benefits?
• Reporting and administration — who will be responsible for calculating and reporting the pension value to HMRC?
• Transitional arrangements — will there be any phasing or grandfathering for existing pension arrangements?
• Interaction with the LSDBA — how will the lump sum and death benefit allowance interact with the new IHT rules?

The government has committed to a further consultation and draft legislation before April 2027. We will update this guide as new information becomes available.

What Should You Do Now?

While the final details are still being worked out, there are practical steps you can take now:

1. Get a full estate valuation — understand the total value of your estate including your pension
2. Review your beneficiary nominations — ensure they are up to date and aligned with your wishes
3. Speak to a financial adviser — get personalised advice on the most tax-efficient approach for your circumstances
4. Review your estate plan — ensure your will, pension nominations, and any trusts work together
5. Do not panic — hasty decisions to withdraw large pension sums could create bigger tax problems than they solve

For more detail on how the current IHT rules apply to pensions, read our guide on pensions and IHT from April 2027. For help with the wider picture, see our guide on common pension and will mistakes to avoid.