Could your pension increase your Inheritance Tax bill? How the 2027 legislation change affects you

For many years, pensions have played an important role in estate planning. Unlike many other assets, unused pension funds could generally be passed to beneficiaries outside the scope of Inheritance Tax, making pensions an attractive way of preserving wealth for the next generation.

From 6th April 2027 this is set to change, most unused pension funds and certain pension death benefits will be brought within the value of an individual’s estate for Inheritance Tax (IHT) purposes.

The changes could have significant implications for how individuals approach their pensions, Wills and wider estate planning.

What are the changes

Currently, most unused pension funds held in discretionary pension schemes are generally outside the estate for IHT purposes.

The Government announced at the Autumn Budget 2024 that this treatment would change. The legislation has now been enacted through Part 2 of the Finance Act 2026, which amends the Inheritance Tax Act 1984 and other legislation.

The new rules will apply to deaths on or after 6th April 2027. From that date, the value of most unused pension funds and pension death benefits will be treated as part of the deceased’s estate for IHT purposes.

This means that, for some individuals, a pension which was previously viewed as an efficient vehicle for passing wealth to the next generation could instead increase the overall IHT liability on death.

Will the whole of my pension be taxed?

Not necessarily. The reform is aimed principally at unused pension funds and certain death benefits remaining when an individual dies.

There are also important exclusions. For example, the Government has confirmed that death-in-service benefits payable from registered pension schemes will remain outside the scope of IHT from 6 April 2027. This applies regardless of whether the pension scheme is discretionary or non-discretionary.

The precise treatment will therefore depend on the type of pension arrangement and the benefits payable on death.

Why does this matter for estate planning?

The change could alter the way some people think about their pensions. Historically, an individual with sufficient other assets might deliberately preserve their pension rather than drawing it during retirement, allowing the pension to pass to beneficiaries on death.

From April 2027, that strategy may have different tax consequences.

For example, imagine an individual has a house and other assets worth £1 million; and an unused pension fund worth £500,000, under the new rules, the pension may need to be taken into account when calculating the individual’s estate for IHT purposes.

Depending on the individual’s circumstances, this could increase the amount of IHT payable and reduce the amount ultimately passing to beneficiaries.

It is therefore important not to look at a Will, pension or other asset in isolation. Estate planning increasingly requires consideration of the way in which all of an individual’s assets interact.

The Nil Rate Band and allowances

The standard IHT nil-rate band is currently £325,000, subject to the usual rules and allowances.

There may also be a residence nil-rate band of up to £175,000 where the relevant conditions are satisfied, including where a qualifying residence passes to direct descendants.

The inclusion of pension wealth within the estate could therefore mean that an estate which previously appeared to fall below the relevant IHT thresholds may need to be reconsidered.

It is particularly important for individuals with substantial pension savings to understand how the new rules interact with their available allowances and the wider structure of their estate.

Married couples and civil partners

The position can become more complicated where assets are passing between spouses or civil partners.

Transfers between spouses and civil partners can generally benefit from the spouse or civil partner exemption, meaning that IHT will not normally be payable on assets passing between them on the first death.

Unused nil-rate band and, where applicable, residence nil-rate band can also potentially be transferred to the surviving spouse or civil partner.

However, the fact that pension funds may now form part of the estate means that pension arrangements should be considered as part of the overall estate planning exercise rather than treated separately.

Next Steps

The changes do not come into force until 6th April 2027, but that does not mean that individuals should wait until 2027 to review their arrangements. If you have a significant pension, it may be worth considering:

• If your Will still reflect who you want to benefit from your estate
• Have you completed an expression of wishes or beneficiary nomination with your pension provider, and is it still appropriate?
• Your overall IHT position
• Your retirement strategy
• If  trusts, lifetime gifting or other planning be appropriate in your circumstances

Importantly, there is no one-size-fits-all answer. Decisions about whether to draw a pension, make lifetime gifts or restructure assets should be considered carefully alongside income requirements, investment objectives, IHT and the individual’s wider circumstances.

The Government’s pension reforms represent a significant change to the relationship between pensions and Inheritance Tax. From 6th April 2027, most unused pension funds and certain pension death benefits will be brought within the IHT regime. For anyone with substantial pension savings, this is a good reason to review their estate plan now rather than waiting until the rules come into force.