Understanding the 2027 pension inheritance tax changes

However, from 6 April 2027, the inheritance tax (IHT) treatment of pensions will change. Some estates could therefore face a larger tax bill, potentially reducing the amount your beneficiaries may inherit. 

Under the current rules, unused pension savings held in most discretionary pension schemes, where trustees or administrators have discretion over who receives benefits, generally sit outside your estate for inheritance tax purposes. 

From 6 April 2027, most unused pension funds and pension death benefits will instead be included in your estate. Their value could therefore be considered alongside assets such as your home, savings and investments when determining whether inheritance tax is payable. 

Separate income tax rules can still apply when someone inherits pension benefits, depending on factors including the pension holder's age when they died and the type of benefit received. Tax treatment depends on individual circumstances and may change in the future. 

The government says pensions are intended primarily to fund retirement but have increasingly been used and marketed as a tax-planning vehicle to transfer wealth between generations. 

It says the new rules are designed to remove this incentive and make the inheritance tax treatment of different pension types more consistent. 

The change is likely to be relevant if you expect to have a significant amount left in a defined contribution pension when you die. This is a pension where you build up a pot through contributions and investment returns. 

The larger the unused pension, the greater its potential impact on your estate, particularly if you had planned to preserve your pension to pass on to family. 

The standard inheritance tax nil-rate band is currently £325,000. This is the amount of your estate that can usually be passed on before IHT becomes payable, subject to exemptions or reliefs.

There is also a residence nil-rate band of up to £175,000 where a qualifying home is passed to direct descendants, such as children or grandchildren. Eligibility rules apply and the allowance is tapered for estates worth more than £2 million. 

Unused allowances can also potentially be transferred between spouses and civil partners. 

Adding previously excluded pension wealth could therefore create an inheritance tax liability where none existed before, or increase an existing bill. The inheritance tax allowances and reliefs referred to in this article are based on current legislation and could change in the future. 

The changes could be especially significant if you intend to leave unused pension savings to children, grandchildren or other beneficiaries who do not qualify for an inheritance tax exemption. 

Transfers between spouses and civil partners can generally continue to benefit from the existing exemption. Including a pension in the estate therefore does not automatically mean IHT will become payable where it passes to a spouse or civil partner. 

The changes are not limited to defined contribution pensions. Certain death benefits associated with defined benefit pensions, which generally promise a retirement income based on factors such as salary and length of service, could also be affected. 

Not every pension benefit will be included under the new rules. 

Certain joint-life annuities will be excluded, including qualifying dependants' or nominees' annuities purchased together with the member's own lifetime annuity. A joint-life annuity continues paying an income to another person, such as a spouse or partner, after the original annuity holder dies. 

Qualifying dependants' scheme pensions and death-in-service benefits will also be excluded. 

For many people, pensions have historically been considered separately from their estate when thinking about inheritance. From April 2027, that may no longer be appropriate. 

The changes could affect not only how much inheritance tax your family pays, but also how you use different sources of wealth during retirement. 

What this doesn't mean is that you must start withdrawing money from your pension simply to reduce a future tax bill. Pension withdrawals can have their own tax consequences, and the right balance will depend on your circumstances, retirement needs and who you want to pass on your wealth to. It's also important to remember that the value of pension and investment arrangements can go down as well as up, and the benefits available will depend on your personal circumstances. 

With these changes significantly altering the IHT treatment of pensions, it may be worth reviewing your retirement and inheritance plans before April 2027. Understanding how your pension fits alongside your property, savings and investments can help you make informed financial decisions and plan how to pass on your wealth in line with your intentions. 

This article is for information purposes only. It is not intended as investment advice. 

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