Families are facing a major shake-up to the inheritance tax regime from April 2027 when unused pensions will form part of estates for inheritance tax (IHT) purposes.
Historically, many pension pots have fallen outside the IHT net, making them a useful vehicle to transfer wealth through generations. But under new rules, announced in the 2024 Autumn Budget by then chancellor Rachel Reeves, unused pension funds will no longer be able to be passed down without facing an IHT liability from 6 April 2027. The change is expected to drag over 10,000 extra estates into the IHT net in 2027/28.
Gary Smith, senior client partner at wealth manager Evelyn Partners, said the rule change will have major impacts on how people spend their pensions in retirement as well as making wills and estate planning far more complex.
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But while the headline would suggest all pensions will fall under the scope of IHT, the rules are more nuanced than this.
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Here's everything that is expected to change and how to prepare.
How will inheritance tax be applied to pensions from April 2027?
From April 2027, most unused pension funds and pension death benefits will be liable for an IHT bill, should it tip the value of an estate over the nil-rate band of £325,000.
Specifically, this is what will be included for IHT purposes:
- Personal (private) or occupational defined contribution (money purchase) pension funds
- Any inherited pension funds that remain in drawdown
- Pension funds that are paid into a trust on death
- Guaranteed payment period income or value protection lump sums paid from an annuity
- Defined benefit (final salary) lump sum death benefits
When inheritance tax won’t be owed from April 2027
There are some circumstances when IHT won’t be owed after the new rules come into force. These include:
Death in service benefits
Death in service benefits linked to either a defined contribution or defined benefit pension will not be liable for IHT. Death in service benefits are payments made to the beneficiary of a pension owner who dies while working for a company.
Clare Moffat, pensions and tax expert at pensions and investment firm Royal London, said it’s worth updating paperwork to ensure your death in service benefit goes to the person you want it to.
“Many people fill in an expression of wish form when they start a job – one for their pension and one for the death in service scheme,” Moffat said. “Keeping both up to date is important. If you die while still working, it allows the scheme administrator to know who you’d like to receive the death benefits.”
Dependants’ scheme pensions
A dependants' scheme pension, which pays a regular income to a “dependant” on the pension holder’s death, will not be subject to IHT under the new changes. The government defines a “dependant” as a surviving spouse, civil partner, child or anyone else who is financially dependent on you.
Trivial commutation
This is a lump sum payment, instead of a regular monthly one, made from an inherited dependants' scheme and will also be exempt. The lump sum has to be under £30,000 to qualify for trivial commutation.
Joint-life annuities
No IHT will be owed on joint-life annuities, which pay out to another person on your death.
Joint-life annuities usually pay out to surviving spouses, civil partners or to people who are financially dependent on you.
Death benefits paid to spouses, civil partners or charity
Death benefits transferred to a spouse or civil partner won’t be subject to IHT, if they are UK long-term UK residents. The same rule applies if pension death benefits are paid to charity.
The state pension
The state pension will not fall within the scope of inheritance tax from April 2027 and will apply only to personal and workplace pension schemes.
Why the majority of estates won’t owe inheritance tax after the changes
The government estimates that of the roughly 213,000 estates with inheritable pension wealth in 2027/28, around 10,500 will have an IHT liability where they wouldn’t have before.
Moffatt, from Royal London, said: “Many people are concerned about pensions being subject to inheritance tax, however, even with pensions being included, the majority of estates won’t have to pay it.
“Most people will need their pensions in retirement and if they don’t use the whole pot, it will pass to a husband, wife, or civil partner inheritance tax-free.”
That said, those who are wealthier will obviously be at greater risk of being dragged into paying IHT, or paying a higher amount than they would have before, from April 2027.
Anyone in this position should consider how gifting can reduce an eventual IHT bill while providing financial support to a loved one.
