Does your family face a triple tax blow after inheritance tax changes? How to limit the impact
Unused pensions will fall under the scope of inheritance tax from April 2027 – and it could see some families left with sizeable tax bills.
Families could be stung with a triple tax blow from next year when inheritance tax changes come into effect – but there are ways to lessen the hit.
Most unspent pensions will become subject to inheritance tax (IHT) in April 2027, which could leave some families facing IHT, an income tax bill and the loss of the residence nil-rate band allowance.
How families could be hit
Everyone has an allowance known as the nil-rate band which means estates worth less than £325,000 are not subject to IHT.
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You can also benefit from a further £175,000 allowance known as the residence nil-rate band if you are passing your home to a direct descendant such as a child or grandchild.
Any unused amounts from these two allowances can be passed onto a spouse or civil partner, meaning some estates worth up to £1 million have no IHT liability.
However, the residence nil-rate band is cut by £1 for every £2 an estate is worth over £2 million.
If you are single, you lose your entire residence nil-rate band once your estate is worth £2.35 million or more and if you are in a couple you lose it all if the estate is worth £2.7 million or more.
The inclusion of most unused pensions within estates for IHT purposes from April 2027 could see more people losing their residence nil-rate bands.
Beneficiaries also have to pay income tax on any unused pension funds if the deceased was 75 or older when they died.
This means, from April 2027, some estates are facing a triple tax hit, when combining IHT and income tax on pensions, plus the loss of the residence nil-rate band.
According to calculations by insurance firm NFU Mutual, some estates may have an effective 91% tax charge on inherited unused pensions.
Adam Cole, retirement specialist at wealth management firm Quilter, said: “The prospect of some families facing an effective tax rate of over 90% on inherited pension wealth highlights just how significant the inheritance tax changes coming in from April 2027 will be.
“While these are quite extreme scenarios, many more families will find pensions that were previously outside the inheritance tax net are now contributing to much larger tax bills.”
| Row 0 - Cell 0 | Today (dies pre-75) |
From April 27 (pre 75) |
From April 27 (post 75) |
Estate £2m, plus £700,000 pension |
£2m |
£2.7m |
£2.7m |
Nil rate band |
(£650,000) |
(£650,000) |
(£650,000) |
Residence NRB |
(£350,000) |
Nil |
Nil |
IHT |
£400,000 |
£820,000 |
£820,000 |
Income tax (45%) |
Nil |
Nil |
£219,326 |
Received by family |
£2.3m |
£1,880,000 |
£1,660,674 |
Extra tax |
Nil |
£420,000 (60%) |
£639,326 (91.3%) |
Source: NFU Mutual
How to lower the impact from a potential triple tax blow
Gifting
Making gifts throughout your lifetime is one of the simplest ways you can lower the value of your estate, and a potential IHT bill.
There are various gifting allowances. For example, you can give away up to £3,000 tax-free each financial year to one or more people. This is known as the annual exemption.
You can also make regular gifts to people, as long as they’re made out of income and not capital and they don’t affect your standard of living.
This is known as ‘expenditure out of income’ and can include regularly paying rent for a child or adding money into an under 18’s savings account.
There are other inheritance tax allowances, plus if you give a gift at least seven years before your death, it won’t be subject to inheritance tax – unless the gift is part of a trust.
Sean McCann, chartered financial planner at NFU Mutual, said: “Making gifts during your lifetime is one of the most effective ways of reducing inheritance tax.
“While some gifts are immediately exempt, including gifts up to £3,000 each tax year and regular gifts from income that don’t compromise your normal standard of living, most others require you to survive seven years.
“In many circumstances it will be possible to take out a life insurance in trust to meet any potential inheritance tax liability on the gift.”
Take your 25% tax-free lump sum earlier
You can withdraw as much as 25% from your pension pots as a lump sum, up to a maximum of £268,275, from age 55 currently and from 57 from April 2028.
The advantage of doing this earlier is that it reduces your capital and the size of your estate.
However, there are drawbacks to taking the lump sum early, namely that the size of your pot will become smaller and there is less in there to continue growing.
Consider an annuity
Buying an annuity could be another option to lower the value of your estate.
An annuity is an insurance product which offers you a regular payment for a specific period of time in exchange for a lump sum of cash.
By buying one, you’re taking capital out of your estate and potentially lowering an eventual IHT bill for your loved ones.
Annuity rates have increased in recent years, making them a more attractive proposition. Sales of annuities have increased by 7.8% from 82,061 in 2023/24 to 88,430 in 2024/25, according to the Financial Conduct Authority.
Ed Wood, financial planning director at wealth manager Rathbones, said: “We would not advocate annuity purchases simply to avoid future inheritance tax, but the relative merits of annuity vs drawdown have slightly changed. For anyone who had previously ruled this out, it may be worth a second look.”
