Changes to Inheritance Tax (IHT) on Pensions from 2027

The UK system for inheritance tax is set for a significant overhaul from April 2027, with pension pots now being brought within the scope of IHT for the first time.

This is one of the most substantial changes to estate planning in recent years, and it’s vital that, if you’re approaching retirement or when the time to make important financial decisions is drawing closer, you pay close attention to this impending change.

Planning effectively now will ensure that, if any of your pensions are subject to inheritance tax, you can optimise your financial position and preserve the maximum net value of your estate.

A Summary of UK Inheritance Tax Changes on Pensions in 2027

At present, defined contribution pensions (i.e. where you build up a pot of money to give you an income when you retire) are not subject to inheritance tax because it doesn’t form part of your estate.

However, from 6 April 2027, defined contribution pensions will be included in your estate’s value when calculating inheritance tax liability, potentially subjecting them to the standard 40% IHT rate.

In the Autumn Budget, Chancellor Rachel Reeves announced that inheritance tax thresholds (the amount you can pass on after you die) are remaining the same until 2030. However, pensions will no longer be exempt from IHT.

This shift brings the UK more in line with how other assets are treated, but removes a significant tax advantage that many have relied upon in their financial planning.

Who Will Be Affected by the 2027 IHT Tax Change?

The good news is that inheritance tax won’t suddenly affect everyone, as each individual retains their £325,000 nil-rate band, meaning you can still pass this amount on to anyone without paying inheritance tax.

For married couples and civil partners, this effectively doubles to £650,000, as unused nil-rate bands can be transferred between spouses. This means that when the first member of the couple dies, and anything they own is passed to their surviving spouse or civil partner, then no inheritance tax will be due.

Additionally, the residence nil-rate band provides up to £175,000 per person (£350,000 for couples) when passing property to direct descendants. This means married couples can potentially pass up to £1 million inheritance tax-free when leaving their home to children or grandchildren.

However, some estates will be facing inheritance tax for the first time due to these incoming pension changes. Individuals with substantial pension savings and property ownership, or those who have inherited their spouse’s pensions and accumulated a healthy amount of wealth for retirement, will likely pay more tax.

It’s also important to note that inherited pensions may also face double taxation: inheritance tax when you die, followed by income tax when pension funds are withdrawn. This makes the impact on larger and more complex estates even more substantial.

How to Plan for These IHT Tax Changes

Lifetime giving: Regular payments from surplus income, annual exemptions of £3,000, and larger gifts (subject to seven-year survival rules) can help reduce your estate’s value.

Pension withdrawal strategies: For those over 75, beneficiaries face income tax on inherited pensions anyway. This means that inherited pensions could face a double tax hit – first inheritance tax at 40% on the estate, plus income tax when beneficiaries draw from that pension. Carefully planned withdrawals during your lifetime might prove more tax-efficient than leaving large pension pots to be taxed, once for inheritance tax and another for income tax.

Proactive estate planning: Trusts, business property relief opportunities, and coordinated withdrawal strategies require expert navigation. Consider consulting a professional estate planning expert to decide on the most appropriate strategy for your circumstances.

Professional Inheritance Tax Advice

These changes represent a significant shift in how we will approach retirement and estate planning in the coming years. Understanding our responsibilities regarding pension taxation, inheritance tax, and income tax is vital, as the initial outlook for the new changes suggests there will be a complex web to navigate.

The personal tax strategies that worked in the past may no longer be optimal come April 2027, and new strategies may need to be developed to ensure you’re in the best possible financial position.

At Hamlyns, we’re already helping clients understand these changes and adapt their financial strategies accordingly. Our professional tax advisors will ensure you’re prepared for 2027 and beyond, offering personalised advice that considers your unique family situation and financial goals.

We recommend you start planning now, with legislation still being finalised. There’s time to implement strategies and make adjustments before the changes take effect. Contact Hamlyns today to discuss how these inheritance tax changes might affect your estate planning and what steps you can take to protect your family’s financial future.