UK Pension Inheritance Tax Changes

Under current law most unused pension pots and death benefits may be left to loved ones without forming part of the deceased’s estate for purposes of Inheritance Tax (currently chargeable at 40% attributable to any chargeable estate above the various nil rate bands). Currently the UK’s Inheritance Tax “nil rate band” (zero percent cap) is £325,000 per person (plus there is an additional Principle Private Residence “nil rate band” of £175,000 per person). In the context of global tax systems, this is certainly higher than some European systems, though considerably less than others such as the United States, which currently stands at $13.99 million federal estate and gift tax.

The 2027 reforms represent one of the most significant changes to pension taxation in a generation. The government’s draft legislation on pension taxation has now been published—although final details may still evolve. What we do know already represents a major shift in how pensions are treated upon death and how families pass on accumulated wealth.

Key Change: Pensions Will Become Part of the Taxable Estate

From April 6, 2027, any unused pension funds upon death will become subject to Inheritance Tax (IHT), except when benefits pass directly to a surviving spouse or civil partner. The spousal exemption continues to apply, but upon the second death, any remaining funds will form part of the survivor’s estate and may then be taxed at up to 40% IHT.

This effectively ends the long-standing ability to use pensions as a tax-free intergenerational wealth transfer vehicle.

Understanding the New Double-Tax Risk

While the income tax rules before and after age 75 remain unchanged, the addition of IHT can now create double taxation for many beneficiaries.

Let’s break down what that means:

Before age 75: For those who’ve previously received UK pensions advice, the previous Lifetime Allowance (LTA) figure of £1,073,000 (non-protected or enhanced) will likely be familiar to you. This referred to a maximum allowance of pension benefits an individual could accumulate during their lifetime without having to pay tax on the excess. The LTA was abolished on April 6, 2024. This same figure now forms the basis for the Lump Sum Death Benefits Allowance (LSDB).
In 2025–2026 tax year, the standard Lump Sum and Death Benefit Allowance (LSDBA) is £1,073,100, and the standard Lump Sum Allowance (LSA) is £268,275. Meaning we can withdraw a tax-free lump sum of up to a maximum of £268,275 (25%) from our pension(s) during our lifetime. However, if the fund exceeds this limit and is paid to anyone other than a spouse, IHT will also apply—potentially triggering both income tax and inheritance tax.
After age 75: Any funds passed to non-spouse beneficiaries will now face both income tax (up to 45%) and IHT (up to 40%). For example, a pension worth £1 million left to an adult child could incur a combined effective tax rate of around 67%, leaving the beneficiary with only £330,000 after both taxes. In certain circumstances—such as where the death benefits reduce personal allowances or remove eligibility for the residence nil-rate band—the effective marginal tax rate could rise as high as 90%.

For most clients, the idea that heirs might receive just 10% of the pension fund’s value will come as a shock.

Strategic Planning Considerations

While legislation is still in draft form, the direction of travel is clear. The coming years offer a crucial opportunity to plan proactively.

Practical steps to consider:

Review pension wealth relative to total estate value: If your pension assets make up a large portion of your estate, you may wish to begin gradual decumulation—drawing on pension funds earlier, rather than deferring indefinitely.
Utilize lifetime gifting strategies: If withdrawals from your pension are not needed to maintain your lifestyle, consider taking lump sums and gifting excess funds while alive. This starts the seven-year clock for IHT taper relief and allows you to manage your exposure proactively.
Coordinate estate and pension planning: Ensure your beneficiary nominations and trust structures align with your broader succession strategy. In some cases, it may make sense to hold more long-term family assets in trusts or investment companies rather than in pensions.
Reassess life cover and liquidity: For larger estates, it may be worth exploring life assurance solutions designed to offset the future IHT charge on pension wealth.

Summary

The 2027 reforms represent one of the most significant changes to pension taxation in a generation. While spouses remain protected, children and other beneficiaries will no longer enjoy tax-free inheritance of pension wealth.

For high-net-worth individuals, this underscores the importance of reviewing pension and estate plans now—before these new rules take effect—to safeguard family wealth and avoid unintended tax erosion.

Action Point: If your pension forms a substantial part of your estate, now is the time to model potential IHT exposure and discuss decumulation or gifting strategies that fit your broader financial objectives.

For more information on modeling your inheritance tax exposure, or discussions on decumulation or gifting strategies, please reach out to one of our wealth planners.

Sources:

https://www.gov.uk/guidance/find-out-the-rules-around-individual-lump-sum-allowances

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