For decades, your pension has been outside your estate, no matter how large it has grown. It could be used to transfer property to the beneficiary without paying inheritance tax (IHT).Â
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From 6 April 2027, any unused pension funds will be added to the inheritance tax. As a result, thousands of families will exceed the IHT threshold of £325,000 for the first time.Â
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This change is important for those who are retired with a Self-Invested Personal Pension, savers in a workplace scheme, or those trying to leave something for their inheritance.
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The good news is that you have enough time to prepare. But first, you need to understand what’s actually changing and how it affects you. TAJ Accountants will help you outline the practical steps to take before the changes take effect.
What is Inheritance Tax on Pensions?
Inheritance tax on a pension is a tax on the money, estate, investment, and unspent pension you leave when you die. In the UK, the Inheritance Tax threshold is £325,000, which is known as the nil-rate band. Means you don’t need to pay any IHT tax for this amount. But if your estate value exceeds this threshold, you have to pay tax on the excess amount at 40%.Â
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Many people use pensions to keep wealth in a secure place for retirement or something to pass on. HMRC didn’t count it when working out the IHT threshold. But from April 2027, this rule will change. Your pension will count as part of your estate.
Key Changes Under the New Rules
The 2027 change will affect you if the total value of your estate, including any unused pension or pension death benefits. These changes are based on the UK government’s current legislation and guidance.
Pensions Are Added to Your Estate
After the changes, from April 2027, your unused pension funds or death benefits will be included in your estate for inheritance tax purposes. You won’t have to pay if the property value still falls below the threshold. But many people will have to pay IHT over this range.
Both DC and DB Pensions Are Affected
Under new legislation, unspent defined contribution (DC) pension funds and defined benefit (DB) schemes will change fundamentally. Any unspent DC funds on death will be added to the deceased’s estate for IHT purposes. Even if the pension is held within a discretionary trust, the trustees exercise their discretion.
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For DB schemes, lump sum death benefits, Pension protection lump sums, and Certain death-in-service payments will be included in IHT assessments.
40% Tax Rate Applies Above the Nil-Rate Band
The new change will affect the residence nil-rate band (RNRB). Until now, this band has provided an extra £175,000 IHT allowance when the estate is transferred to descendants according to a tapering rule.
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If the estate value exceeds £2 million, the RNRB starts to reduce by £1 for every £2 above the threshold. After adding the pension, more estates will cross the £2 million threshold that reduces the RNRB by £125,000. Additionally, this increases IHT liability at the 40% rate.Â
Remain Key Exemptions Under the New Rule
Some important exemptions remain under the Finance Act 2026. Death-in-service benefits, Dependants’ scheme pensions, and Spouse and Civil Partner pension Exemption will remain outside of the estate for IHT.
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Charity lump sum death benefits will also remain exempt from IHT. A trivial commutation lump sum valued at under £30,000 is treated continuously with the pension income exemption.
Personal Representatives Take On Responsibility
Under the new rules, personal representatives or executors will calculate, report and pay the IHT directly to HMRC. Now, pension scheme administrators handle this burden. The legal representative can hold the pension death benefits up to 50% to work out any potential Inheritance Tax (IHT) liability arising from pension benefits before the full pension fund is paid to beneficiaries.
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It helps to ensure there is enough money available to cover any IHT that may become due on the pension benefits under the new rules.
Withholding Notice PowerÂ
In new changes, HMRC introduces a new Withholding Notice Power to help the personal representatives cover IHT liabilities. They request a pension scheme administrator to withhold up to 50% of a deceased member’s pension death benefits. The estate can pay its IHT by using this pension within 15 months after the end of the month in which the individual died.
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This Withholding Notice provides great flexibility and efficiency to avoid the risk of funds shortage for IHT under the new pension and IHT framework.
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Why Are the Rules Changing?
HM Revenue & Customs (HMRC) changes pension inheritance tax rules because they believe pensions are used as a tax loophole instead of retirement. Many wealthier people spend their savings or ISAs first and keep pensions reserved because income from pensions is tax-free. This created an inconsistency and a tax planning loophole under IHT.
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Under the new rules, including pensions in IHT will increase the tax. HMRC calculates that, in 2027 to 2028, 10,500 estates will have to pay an Inheritance Tax of around 213,000 with inheritable pension wealth.Â
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Again, approximately 38,500 estates will need to pay Inheritance Tax more than before. The average estimate of Inheritance Tax liability will increase by around £34,000 if the pension is included in the value of the estate. These changes make tax treatment fairer and more transparent.
Conclusion
The upcoming UK inheritance tax pension rules changes create a significant dimension in estate planning. At present, pension consider an important tax-efficient way to transfer wealth to the beneficiaries. From April 2027, this facility will be removed due to adding a pension to an estate for IHT. It maximises the tax burden and minimises the value of inheritance. Personal representatives, pension scheme administrators, and families are to take a more proactive approach to managing estate affairs due to the addition of new administrative reforms.
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At TAJ Accountants, we create a fairer and more consistent tax system to highlight the importance of reviewing existing retirement and inheritance plans. Our professional tax expert provides proactive support for individuals with significant pension savings to understand how the new rules may affect their estate. To explore real-time strategies and preserve wealth for future generations, book a free consultation as early as possible.
Frequently Asked Questions
No. The State Pension is a government benefit that provides an income for people in retirement. It is not an asset you own or accumulate. Only private pension will add into your estate.
Yes. Under the new Inheritance Tax (IHT) rules, any remaining funds in a pension that is in flexible drawdown will be considered as unused pension. And it will be included in your estate for IHT purposes when you die.
Yes. Both SIPPs (Self-Invested Personal Pensions) and workplace defined contribution pension schemes are included in the same way for Inheritance Tax.
Transfers of pension benefits to a spouse or civil partner are exempt from Inheritance Tax on the first death. But from April 2027, the inherited pension may be included for IHT when estimating the surviving spouse’s estate value. The impact will depend on the value of the surviving spouse’s estate and the reliefs available.
Pension will be added in calculating the total value of your estate. If the overall remains below the available Inheritance Tax nil-rate band, no IHT will apply. Most UK estates will keep out of the IHT.
