For decades, one of the most powerful features of a pension has been its position outside your estate for inheritance tax purposes. Unlike property, savings accounts or ISAs, unused pension funds have generally not been counted when calculating how much IHT your estate owes. For many people with larger pension pots, this made the pension one of the most tax-efficient assets to preserve and pass on to the next generation.

That changes in April 2027. Following the Autumn Budget 2024, the government confirmed that most unused pension funds and pension death benefits will be brought within the scope of inheritance tax from 6 April 2027. It is one of the most significant shifts in pension planning in a generation — and if you have a meaningful pension pot, it is worth understanding what is changing and why it matters.

What is changing and when?

Currently, defined contribution pensions — including SIPPs, personal pensions and most workplace money purchase schemes — sit entirely outside your estate for IHT. This means that if you die with funds remaining in your pension, those funds pass to your nominated beneficiaries without attracting inheritance tax, regardless of how large the pot is.

From 6 April 2027, the value of most pension death benefits must be included when calculating an estate’s inheritance tax liability. The Chancellor’s stated intention was to restore the principle that pensions should not be a vehicle for the accumulation of capital sums for the purposes of inheritance, as was the case prior to the 2015 pension reforms.

The change applies to people who die on or after 6 April 2027. For deaths before that date, existing rules and processes will apply, even if the pension scheme pays benefits after the implementation date.

How will IHT on pensions actually work?

Under the new rules, your unused pension pot will be added to the rest of your estate. If the combined value exceeds the available nil-rate band allowances — currently £325,000 per person, or up to £1,000,000 for a married couple passing a family home to children — the excess is taxed at 40%.

The IHT is deducted from the pension before the beneficiary receives it — your executors do not need to fund the IHT bill from other estate assets. Personal representatives will be responsible for reporting and paying any inheritance tax due on unused pension funds and death benefits.

Personal representatives will be able to direct pension scheme administrators to pay IHT directly to HMRC before any pension funds are released to beneficiaries. They will also have the power to issue a ‘withholding notice’ instructing administrators to withhold up to 50% of the pension funds for up to 15 months from the date of death, to allow time for the IHT position to be finalised.

Who is actually affected?

It is important to keep this in perspective. The government estimates that, out of around 213,000 estates with inheritable pension wealth in 2027 to 2028, approximately 10,500 estates — around 1.5% of total UK deaths — will become liable for inheritance tax where this would not previously have been the case.

That said, the people most likely to be affected are those who have been deliberate and successful pension savers — often professionals, business owners and those with workplace final salary pensions alongside a SIPP. If you have a pension pot of £200,000 or more alongside other assets, it is worth reviewing your position even if your overall estate is not currently above the IHT threshold, because pension growth between now and 2027 (and beyond) could change that picture.

The spousal exemption — an important protection

One significant protection remains in place. Pensions left to a surviving spouse or civil partner will remain IHT-free under the existing spousal exemption. This mirrors the existing treatment of other assets passing between married couples and civil partners.

This makes the decision about who to nominate as your pension beneficiary even more important. Leaving your pension to your spouse avoids IHT on the first death, but it concentrates the pension in the surviving spouse’s estate, where it could face IHT when they die.

For couples with substantial pension assets, this creates a genuine planning question: is it better to leave the pension to a spouse and defer the IHT question, or to start drawing from the pension now and use other strategies to reduce the estate over time? There is no universal answer — it depends on your ages, health, other assets and income needs.

The double taxation concern

Beyond the headline IHT charge, there is a deeper issue that affects pensions passed to non-spouse beneficiaries, particularly adult children. It is sometimes called the “double death tax”.

If you die aged 75 or over, your beneficiaries could face IHT at 40% on the pension value, plus income tax at up to 45% on withdrawals from the inherited pension. The combined effective tax rate on large pensions passed to higher-rate taxpaying children could reach 64% to 67%, or even higher.

Questions remain around double taxation and transitional rules, and whether any further relief will be provided to prevent overlapping income and inheritance tax charges on the same funds. Until HMRC issues detailed guidance, assumptions must be made based on existing principles.

What about death in service and defined benefit pensions?

Death in service benefits — lump sums paid out if you die while still an employee — and dependants’ scheme pensions from defined benefit (final salary) schemes will generally stay outside the scope of IHT. These are important exceptions worth understanding if you have employer-provided life cover or are a member of a public sector scheme.

What does this mean for your retirement planning?

The change fundamentally alters one of the core assumptions that has shaped pension drawdown strategy for the last decade. Many people with significant pension savings have deliberately drawn on other assets first — ISAs, savings, property — and left the pension untouched because it sat outside the estate. From April 2027, that strategy is effectively redundant.

This does not mean everyone should immediately start drawing down their pension. For many people, the pension remains the most tax-efficient wrapper available during their lifetime, and the income tax benefits of pension saving — tax relief on contributions at your marginal rate — remain unchanged. The question is how to balance those lifetime advantages against the estate planning implications.

The areas most likely to need review include:

• Beneficiary nominations. Who have you nominated to receive your pension on death, and does that still make sense given the new tax treatment? Nominations to a spouse remain IHT-efficient; nominations to children or grandchildren now carry a potential IHT charge.
• Drawdown sequencing. In what order should you draw from your pension, ISA and other assets? The optimal approach may have changed significantly for people with large pensions relative to their other assets.
• Gifting strategies. Making use of annual gifting exemptions and potentially exempt transfers over the next few years could reduce the overall estate, including the pension component once the rules change.
• Life insurance in trust. A whole-of-life insurance policy written in trust can be sized to cover the expected IHT on pension funds. The policy payout falls outside the estate if written in trust, providing liquidity to pay IHT without reducing the pension passed to beneficiaries.
• Estate structure review. For those with estates significantly above the nil-rate band, the interaction between pension IHT, residence nil-rate band tapering and other assets may need a comprehensive review.

When should you act?

April 2027 may feel some way off, but the planning required is not trivial. Changing beneficiary nominations is straightforward, but reviewing drawdown strategy, restructuring gifting arrangements or putting life insurance in trust all take time and require advice tailored to your full financial position.

Advisers need to start preparing clients for these changes now. The same is true for individuals. Waiting until late 2026 to seek advice leaves little time to implement changes effectively before the rules come into force.

If you have a pension pot of meaningful size — particularly if your overall estate already approaches or exceeds the nil-rate band thresholds — now is the time to understand your position and consider what, if anything, needs to change.

Written by Kris Dabner — Chartered Financial Planner

Kris is the founder of KMD Financial Planning LLP, an independent Chartered Financial Planner based in Hartley, Kent. He provides whole‑of‑market advice across pensions, investments, estate planning, mortgages and protection to individuals and families across Kent and the South East. Learn more about Kris.