Pension Inheritance Tax Changes from April 2027 FAQ

Pension Inheritance Tax Changes from April 2027: Your Frequently Asked Questions Answered

By Liz Williamson – Senior Tax Manager

From 6 April 2027, most unused pension funds will no longer sit outside the inheritance tax (IHT) regime. This is one of the most significant estate planning changes in recent years and will require many individuals to rethink how they pass wealth to the next generation. The changes will primarily affect defined contribution pension arrangements. Certain benefits payable from defined benefit and collective money purchase arrangements may continue to fall outside the IHT charge.

Below we answer some of the most common questions about the changes and outline the planning opportunities that may be available.

What is changing from 6 April 2027?

Unused pension funds and certain pension death benefits will form part of an individual’s estate for IHT purposes from 6 April 2027. Previously, pension funds were generally outside the scope of IHT, making them an attractive vehicle for passing wealth to future generations. The new rules are intended to ensure that pensions are used primarily for retirement provision rather than as an inheritance tax planning tool.

The residual value of a defined contribution pension that remains on death will now be included when calculating the value of the deceased’s estate.

Will all pension death benefits be affected?

No.

Death in service benefits payable from registered pension schemes will remain outside the scope of inheritance tax. In addition, the normal spouse and charity exemptions will continue to apply. This means that if pension assets are left entirely to a spouse, civil partner or qualifying charity, there should be no inheritance tax charge.

Will beneficiaries still pay income tax on inherited pensions?

Yes.

The inheritance tax changes do not alter the existing income tax rules.

For defined contribution pensions:

• If the pension holder dies before age 75, beneficiaries can generally access inherited pension funds free of income tax.
• If the pension holder dies at or after age 75, beneficiaries will normally pay income tax at their marginal rates when they withdraw funds.

The result is that some inherited pension funds could suffer both inheritance tax and income tax, significantly reducing the amount ultimately received by beneficiaries.

How much tax could be payable on inherited pension funds?

The combined tax burden could be substantial.

For example, where a pension fund is inherited by an adult child following the pension holder’s death after age 75:

• Inheritance tax could apply at 40%.
• Income tax could apply when benefits are withdrawn.
• Higher-rate or additional-rate taxpayers could face income tax rates of up to 40% or 45%.

The combined effect of inheritance tax and income tax can significantly reduce the value ultimately received by beneficiaries.

Who is responsible for paying the inheritance tax?

The administration of the inheritance tax liability will generally fall to the deceased’s personal representatives or executors. However, the economic burden of the tax is intended to fall on those beneficiaries receiving the pension benefits.

Given that inheritance tax is normally payable within six months of death and often before probate is granted, liquidity and cashflow planning will become increasingly important.

Should I still preserve my pension and spend other investments first?

Historically, many advisers recommended drawing on non-pension assets such as:

• ISAs
• Cash savings
• General investment portfolios

before touching pension funds because pensions were outside the IHT regime. Following the 2027 changes, this strategy may no longer be the most tax-efficient approach for everyone. The order in which assets are accessed during retirement should now be reviewed as part of a wider financial and succession planning exercise.

Should I consider making lifetime gifts?

Potentially.

Making gifts during your lifetime may reduce the value of your estate and therefore the inheritance tax payable on death. Cash gifts are usually treated as Potentially Exempt Transfers (PETs), meaning:

• No inheritance tax is payable if you survive seven years.
• If death occurs within seven years, some or all of the gift may become chargeable.
• Reduced rates of inheritance tax may apply if you survive at least three years.

For many individuals, lifetime gifting may become more attractive than retaining wealth within a pension fund.

Is it worth taking my pension tax-free cash?

If you have not already crystallised your pension, it may be worth reviewing whether taking your tax-free lump sum should form part of your planning strategy. In many cases, up to 25% of pension benefits can be taken as a tax-free lump sum (subject to available allowances).

Where the funds are subsequently gifted:

• The gift would generally be treated as a PET.
• No inheritance tax should arise if you survive seven years.
• Taper relief may apply if death occurs after three years.

The suitability of this approach will depend on your retirement income requirements and wider financial circumstances.

What about withdrawing more of my pension during retirement?

Some individuals may consider drawing pension benefits earlier or more aggressively than originally planned. While withdrawals will generally be subject to income tax, this may reduce the size of the pension fund exposed to inheritance tax on death.

If the withdrawn funds are subsequently gifted, the usual PET rules can apply.

The balance between an immediate income tax cost and a future inheritance tax saving needs careful modelling and professional advice.

Can I give money away using the gifts out of income exemption?

Possibly.

The gifts out of surplus income exemption remains one of the most valuable inheritance tax reliefs available.

Regular gifts can be immediately exempt from inheritance tax provided:

• They are made from surplus income.
• They form part of a regular pattern of gifting.
• The donor retains sufficient income to maintain their normal standard of living.

However, care is needed where pension withdrawals are funding the gifts. Whether pension withdrawals constitute “income” for the purposes of the normal expenditure out of income exemption will depend on the facts. Regular pension payments are generally more capable of being characterised as income than one-off withdrawals specifically made to fund gifts.

By contrast, regular annuity payments are more likely to qualify as income.

Detailed records should always be retained to support claims for the exemption.

Should I consider purchasing an annuity?

In some circumstances an annuity may become more attractive. Converting part of a pension fund into an annuity can provide a guaranteed income stream and may reduce the value of pension funds exposed to inheritance tax on death. The suitability of an annuity will depend on factors such as age, health, income requirements and alternative assets available.

Should I consider life insurance?

Life insurance may become increasingly important after April 2027.

A suitable policy written in trust can:

• Provide funds to meet an inheritance tax liability.
• Create liquidity before probate is granted.
• Help preserve the value ultimately received by beneficiaries.

The suitability and affordability of cover should be reviewed in conjunction with your financial adviser.

Do I need to update my will and pension nominations?

Almost certainly.

The changes mean it is important to review:

• Your will.
• Your expression of wishes or pension beneficiary nominations.
• Any existing succession planning arrangements.
• Trust structures already in place.
• The balance of assets held inside and outside pensions.

Many plans that were highly effective under the current rules may need adjustment once pensions fall within the inheritance tax regime.

What should I do now?

The introduction of inheritance tax on pension funds represents a fundamental shift in estate planning.

The most appropriate response will depend on factors such as:

• Your age and health.
• The size of your pension fund.
• Other assets available to fund retirement.
• Whether you are married or in a civil partnership.
• The likely tax position of your beneficiaries.
• Existing gifting and succession plans.

For many families, the key actions will be to review retirement funding strategies, consider lifetime gifting opportunities and ensure wills and pension nominations remain fit for purpose.

Final Thoughts

For many years defined contribution pensions were among the most effective inheritance tax planning vehicles available. From 6 April 2027 that position changes significantly and many existing estate planning strategies will need to be reviewed.

A holistic review of your estate, retirement income needs and succession objectives will help ensure your wealth passes to future generations in the most tax-efficient way possible.

Please get in touch if you would like to talk this through.