Pensions and inheritance tax: what the April 2027 changes could mean for you
For many people, pensions have become an important part of estate planning. Under the current rules, most unused pension funds and certain death benefits sit outside a person’s estate for inheritance tax (IHT) purposes. This has often made pensions a tax-efficient way to pass wealth to the next generation.
That position is set to change. In the 2024 Autumn Budget, the Government announced that, from 6 April 2027, most unused pension funds and death benefits will be brought within a person’s estate for IHT purposes. This could increase the IHT payable on death and may require many individuals and families to review their estate planning.
A brief reminder: How IHT works
- IHT is generally charged at 40% on the value of a person’s estate above the available tax-free allowances and subject to reliefs and exemptions.
- Assets passing to a surviving spouse or civil partner are usually exempt from IHT.
- Each individual also has a nil rate band (NRB), currently £325,000, and may have a residence nil rate band (RNRB), currently £175,000, where certain conditions are met.
- Unused NRBs and RNRBs can often be transferred to a surviving spouse or civil partner.
The current position
Until 5 April 2027, most unused pension funds (being the amount left in the pension fund) are not included in the pension holder’s estate for IHT purposes. Instead, they usually pass under the pension scheme rules or at the discretion of the pension provider, rather than under the individual’s Will.
What is changing?
From 6 April 2027, most unused pension funds and death benefits are expected to be included in the value of a person’s estate for IHT purposes. This will apply to many private pensions, including discretionary pension arrangements.
Where pension benefits pass to a surviving spouse or civil partner, the spouse exemption should still apply. For many married couples and civil partners, the main impact may therefore be felt on the death of the second spouse.
Some benefits are expected to remain outside the scope of the new rules, including:
- Death in service benefits payable from a registered pension scheme; and
- Dependant’s scheme pensions from a defined benefit arrangement or from a collective money purchase agreement.
Why this matters
- A larger IHT bill
The most immediate consequence is that some estates will face a higher IHT liability, reducing the amount ultimately passing to beneficiaries.
The changes may also impact the residence nil rate band. This allowance is available only if certain conditions are met, including that a qualifying home passes to direct descendants and the estate is not too valuable. Where an estate exceeds £2 million, the residence nil rate band is gradually reduced and may be lost altogether.
For some individuals, bringing pensions into the estate could push the total value above these thresholds, reducing or eliminating the RNRB.
For example, an individual with an estate worth £1.9 million and a pension fund worth £300,000 may retain the full RNRB if they die before 6 April 2027, assuming the relevant conditions are met. If they die on or after 6 April 2027, the pension fund may increase the taxable estate to £2.2 million, reducing the available RNRB allowance.
- A possible double tax charge
A further concern is the interaction with income tax. Under the current rules, if a pension holder dies aged 75 or over, beneficiaries generally pay income tax at their own marginal rate when they withdraw funds from the inherited pension.
Those income tax rules are not expected to change as part of the April 2027 reforms. As a result, some pension funds could be subject to IHT on death and then income tax when beneficiaries later draw funds. The combined tax cost could be significant, particularly for higher-rate or additional-rate taxpayers.
There may be planning options available, but the right approach will depend on the individual’s wider financial and family circumstances.
- More administration for families
The reforms are also likely to make estate administration more complicated. Personal representatives may need to identify pension schemes, liaise with pension providers and factor pension values into the IHT reporting process. This could be particularly burdensome where a person has several pension arrangements.
- Increased charitable gifts
Some individuals choose to leave at least 10% of their net estate to charity under their Will. Where the statutory conditions for the reduced rate of inheritance tax are satisfied, this can reduce the rate of IHT payable on the taxable estate from 40% to 36%. If the proposed changes to the taxation of pension death benefits come into effect, the value of many estates for IHT purposes may increase significantly. As a result, a charitable gift expressed as a percentage of the estate could become substantially larger than originally anticipated, potentially diverting more of the estate to charity than intended.
What should pension holders do now?
Although the new rules are not due to take effect until April 2027, it is sensible to start reviewing your position now. In particular, pension holders should consider:
- reviewing current pension arrangements and checking which benefits may be affected by the proposed changes;
- preparing a clear summary of each pension, including provider details and policy numbers, to help family members and personal representatives;
- reviewing the overall value of the estate, including pensions, and considering whether IHT allowances or reliefs may be affected; and
taking professional advice before making withdrawals, gifts or wider estate planning decisions.
