Can I avoid IHT by stuffing all my money into a pension?
Pensions have offered families a way to avoid inheritance tax when passing on wealth to loved ones after death, but that’s all set to change.
Stuffing your wealth into a pension used to be a smart way to avoid inheritance tax, especially as more families are paying the death duty on their loved ones’ estates, generating record sums for the Treasury.
But from April 2027, inheritance tax will be due on pensions too. We explain the rules around pensions and inheritance tax.
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That’s the same proportion as it has been since 2007 to 2008, and broadly since statistics were first produced. Fewer than half of all deaths in any given year require interaction with HMRC to establish whether there is a liability to be paid, the tax office said.
Yet the amount going to the Treasury via inheritance tax receipts keeps going up. HMRC declared record high levels of IHT receipts for April 2025 to February 2026, amounting to £7.7 billion, which is £0.1 billion higher than the same period last year.
How pensions are taxed when you die
Pensions are taxed differently depending on how old the pension holder is when they die.
If, when you die, you are 75 years old or older and you have the most common type of pension, a defined contribution plan, your beneficiary will pay income tax on their withdrawals at the rate of tax they usually pay – the basic rate (20%), higher rate (40%) or additional rate (45%).
If you are younger than 75 when you die, the beneficiary can withdraw the cash completely tax-free.
Beneficiaries of defined benefit pension plans, also known as a final salary scheme, pay income tax on the payments they receive regardless of your age at death.
Payments made from a joint life annuity to a surviving spouse or from a guaranteed annuity to your beneficiary are subject to income tax.
How inheritance tax on pensions works
Currently – and until April 2027 – unspent pension funds can typically be passed on free of inheritance or income tax if the owner passes away before 75 years old. After the age of 75, beneficiaries receiving pensions pay income tax on their withdrawals but there’s still no inheritance tax to pay.
Robert Leatherland, financial adviser and owner of Bespoke Wealth, said: “After the previous government abolished the lifetime allowance for pensions, people saw this as an opportunity to build up their pension pot, safe in the knowledge their investments would be protected against inheritance tax.”
Many families have used pensions as a way to pass wealth on to the next generation free of inheritance tax. But from April 2027, this will change significantly.
“This will potentially affect how much of not only your pension savings but your overall assets such as property and savings your loved ones will inherit from a lifetime’s work,” added Leatherland.
How inheritance tax on pensions rules are changing
An announcement by chancellor Rachel Reeves made in the 2024 Autumn Budget has set the wheels in motion for big changes when it comes to pensions and inheritance tax.
From April 2027, inherited pension funds will be considered part of the estate for inheritance tax purposes, leaving beneficiaries at risk of an up to 40% tax charge alongside any relevant income tax liabilities.
Inheritances can pass tax-free between spouses and civil partners. Assets passed to any other beneficiary incur inheritance tax at up to 40% on the portion of an estate worth more than £325,000, known as a nil rate band. Married couples or civil partners can inherit any unused nil rate band from their deceased spouse or partner giving them an inheritance tax free allowance of £650,000.
An extra main residence nil rate band of £175,000 per married person or civil partner can also typically be applied when passing on a main residence to a child or grandchild (though this tapers off when the estate is worth more than £2 million). So potentially up to £1 million can be passed on to direct descendents inheritance tax-free.
By changing the rules to include pensions in an estate to calculate inheritance tax, the overall value of the estate will be driven up catching more families in the inheritance tax net.
It’s a prospect causing high earners to reassess their retirement strategies.
Jonathan Halberda, specialist financial adviser at Wesleyan Financial Services, said: “Many are choosing to accelerate pension withdrawals, transfer funds into alternative structures, and seek guidance on gifting and trust planning in an effort to minimise potential inheritance exposure."
How much more inheritance tax will I pay when rules change?
An illustration from investment platform AJ Bell shows the impact of the upcoming change:
- Colin, who is single, dies aged 81 with £200,000 invested in a pension and £500,000 in the rest of his estate (excluding his pension).
- Under the current rules, no inheritance tax is payable on his pension and his loved ones are liable to pay 40% on the value of his £500,000 estate above the nil rate band (NRB).
- £500,000 less £325,000 NRB leaves £175,000 subject to 40% IHT, leaving Colin’s estate with a tax bill of £70,000.
- From 6 April 2027, the whole estate for inheritance tax will be worth £700,000 which means £325,000 of his estate is subject to IHT. This leaves Colin’s loved ones with a tax bill of £150,000.
- Personal representatives – those family members or professional like solicitors who have been chosen to administer the deceased’s estate – will be responsible for reporting and paying the inheritance tax. Under proposed rules, they can issue a ‘withholding notice’ to pension schemes to deduct the tax from the pension funds.
How can I avoid inheritance tax on my pension?
There are ways to avoid IHT on your pension by working with a financial adviser to find the best strategy.
Here are a few strategies:
- Take a regular income from the pension and gift any excess money using the ‘normal expenditure out of income’ rule to gradually transfer wealth without incurring IHT.
- Explore trusts and family investment companies to manage your wealth more efficiently.
- Consider extracting the maximum tax-free cash, currently 25% on most pension schemes, from your pension to gift away under the seven-year rule or wrap it in a trust.
“There’s no one-size-fits-all solution,” said Halberda, of Wesleyan Financial Services.
“What works best for you depends on your personal circumstances. It’s important to work closely with a professional to assess your needs and identify the most effective strategies for you and your loved ones.”
Do spouses pay inheritance tax on pensions?
No, your spouse does not currently face an inheritance tax bill when they are the beneficiary of your pension assets. However, when the surviving spouse passes away, the pension could be subject to IHT if left to children or other beneficiaries.
From April 2027, when pension assets are subject to inheritance tax, the existing exemptions for pension death benefits passing to a surviving spouse or a civil partner if they are a long-term UK resident, or registered charity will be maintained. So unused pensions of any amount left to a spouse or civil partner will still be exempt from inheritance tax.
How much can you put in a pension?
The annual allowance is the maximum amount that can be saved into a pension before you need to pay tax. Or an alternative way to look at it is, the annual allowance is the maximum you can contribute to a pension and still benefit from tax relief.
The standard annual allowance for the 2026/27 tax year is £60,000, but this reduces to an amount between £10,000 and £60,000 if you earn over £200,000. This is called the tapered annual allowance.
