Most unused pension funds and pension death benefits will enter the Inheritance Tax calculation for deaths on or after 6 April 2027. That makes joined-up retirement and estate planning increasingly important.
A significant change to the treatment of pensions
Pensions have traditionally been treated differently from most other assets for Inheritance Tax (IHT). In many cases, unused pension funds could pass to beneficiaries outside the member’s estate. Finance Act 2026 changes that position for deaths on or after 6 April 2027.
From that date, most unused pension funds and pension death benefits will be brought into the value of the estate for IHT purposes. This does not mean that every pension payment will automatically suffer tax. The result will depend on the value and composition of the estate, the beneficiaries, the exemptions and reliefs available, and the terms of the pension scheme.
Death-in-service benefits from registered pension schemes are excluded from the new charge. Certain other benefits are also outside the new rules, including continuing annuities and some small funds. Defined benefit pensions require particular care because there may be no investment pot to inherit, but the scheme may provide survivor pensions or lump-sum death benefits.
How the IHT calculation may work
The standard nil-rate band is currently £325,000. A residence nil-rate band of up to £175,000 may also be available where a qualifying home passes to direct descendants, although it is tapered for larger estates and is subject to detailed conditions. Transfers to a spouse or civil partner are generally exempt from IHT, and unused nil-rate bands may sometimes be transferred to the survivor.
Where tax is due, the standard IHT rate is 40% on the taxable value above the available allowances and exemptions. A reduced 36% rate can apply to the relevant part of an estate where the required proportion is left to qualifying charities.
These figures should never be viewed in isolation. Lifetime gifts, trusts, business or agricultural assets, earlier use of allowances, debts and the ownership of the family home can all affect the calculation.
Income Tax can still matter
IHT is only one part of the picture. The beneficiary’s Income Tax position can also depend on the member’s age at death and the way benefits are taken.
Broadly, where a member dies before age 75, pension death benefits can often be paid without Income Tax, subject to conditions including the lump sum and death benefit allowance and relevant time limits. Where the member dies at 75 or over, pension benefits paid to an individual are normally taxable at the recipient’s marginal rate. Dependants’ scheme pensions are generally taxable as income regardless of the member’s age at death.
The legislation includes mechanisms intended to prevent Income Tax being charged on pension funds used to pay IHT. The practical result will depend on how the tax is settled and how the beneficiary receives the remaining benefits.
What should pension holders do now?
The change is a reason to review planning, not to make a rushed pension withdrawal. Taking money out of a pension may create an immediate Income Tax charge, reduce future retirement income and move funds into an estate in a different form. It may also affect investment strategy, sustainability and entitlement to means-tested benefits.
A sensible review should consider the purpose of the pension, expected retirement spending, other assets, family circumstances and the intended recipients of any death benefits. Pension nominations should be checked and updated, but it is important to remember that an expression of wish usually guides the trustees or provider rather than binding them.
For many families, the right answer will be a coordinated plan involving a financial adviser, solicitor and, where appropriate, a tax specialist.
Key point The 2027 rules change the tax treatment of many pension death benefits, but they do not make pensions unsuitable or require immediate action. The priority is to understand the potential exposure and make decisions in the context of the whole retirement and estate plan.
Important information
This article is for general information only and does not constitute personal financial, legal or tax advice. Tax treatment depends on individual circumstances and may change. The value of investments can fall as well as rise, and you may get back less than you invest. Wills, trusts and estate administration are legal matters and should be discussed with a suitably qualified solicitor. Seek regulated financial advice before changing pension benefits, investments or protection arrangements.
