By Samuel Mather-Holgate

For years, pensions have occupied a particularly valuable place in estate planning.

Unlike most other investments, unused pension funds have generally been able to sit outside an individual’s estate for Inheritance Tax purposes. This has meant that many people have deliberately spent ISAs, savings and other assets first while leaving their pension untouched to pass to children or other beneficiaries.

That strategy is about to change significantly.

From 6 April 2027, most unused pension funds and pension death benefits will be brought within an individual’s estate for Inheritance Tax purposes.

Mather & Murray in the national press
Mather & Murray Financial was featured in the Daily Express discussing the potential impact of the forthcoming inheritance tax changes on pensions.
Read the Daily Express article →

For some families, this could result in substantially larger Inheritance Tax bills. And where a pension passes to beneficiaries following death after age 75, the interaction between Inheritance Tax and Income Tax could, in certain circumstances, produce an effective tax burden of up to 67%.

This is not a reason to panic or start withdrawing pensions indiscriminately.

It is, however, a very good reason to review retirement and estate planning before the new rules take effect.

Key Takeaways

• From 6 April 2027, most unused pension funds and pension death benefits will be included within the estate for Inheritance Tax.
• The reforms have now been legislated through Finance Act 2026 and apply to deaths on or after 6 April 2027.
• Transfers between spouses and civil partners can still benefit from the normal spouse exemption.
• Registered pension scheme death-in-service benefits remain outside the new IHT rules.
• If somebody dies aged 75 or over, pension beneficiaries may also pay Income Tax when they subsequently draw inherited pension benefits.
• In an extreme case involving a fully IHT-liable pension followed by 45% Income Tax on the remaining benefits, the combined tax effect can reach around 67%.
• This does not mean everybody should start withdrawing their pension before 2027.
• Retirement income, gifting, beneficiary nominations, annuities, life assurance and the order in which different assets are spent may all need reviewing.
• Estate planning and pension planning should increasingly be considered together, rather than as two separate exercises.

Mather & Murray in the Daily Express

Mather & Murray Financial has been featured in the Daily Express discussing the impact the forthcoming pension and Inheritance Tax changes could have on families.

The changes are significant because they challenge a financial-planning strategy that has worked well for many years: preserving pensions while spending other assets first.

Read our comments in the Daily Express →

What Is Changing to Inheritance Tax on Pensions?

Under the current rules, most discretionary defined contribution pension funds do not normally form part of somebody’s estate for Inheritance Tax.

That makes pensions quite different from assets such as:

• cash;
• ISAs;
• investment accounts;
• property;
• many other investments.

From 6 April 2027, most unused pension funds and pension death benefits will instead be included when calculating the value of the deceased person’s estate for Inheritance Tax.

HMRC’s latest technical guidance confirms that these reforms have been legislated and will apply to deaths occurring on or after 6 April 2027.

This means somebody with, for example, a valuable property, investments and a large untouched pension could find that their taxable estate becomes considerably larger overnight for IHT purposes.

Will Every Pension Be Subject to Inheritance Tax?

No.

The rules are more nuanced than simply saying that “all pensions will be taxed”.

Most unused pension funds and pension death benefits are being brought within the estate, but there are important exceptions.

For example, death-in-service benefits from registered pension schemes are excluded from the new IHT treatment.

Certain dependant’s scheme pensions and other benefits can also fall outside the new rules.

And crucially, the normal spouse and civil partner exemption remains relevant.

So if pension benefits ultimately pass to a surviving spouse or civil partner and qualify for the exemption, there may be no immediate Inheritance Tax charge.

The position can be very different where pensions are being passed to children, grandchildren or other beneficiaries.

How Much Inheritance Tax Could Be Charged on a Pension?

Inheritance Tax is generally charged at 40% on the taxable part of an estate above the available allowances and exemptions.

That does not mean every pension will suddenly suffer a 40% tax charge.

Whether IHT is payable depends on the value of the entire estate and the allowances and exemptions available.

For example, somebody may have access to:

• the £325,000 Nil Rate Band;
• potentially the Residence Nil Rate Band where the conditions are satisfied;
• unused allowances transferred from a deceased spouse or civil partner;
• spouse or civil partner exemptions;
• other exemptions or reliefs.

Many estates will therefore continue to pay no Inheritance Tax at all.

But for people who already have estates close to or above the IHT thresholds, adding a substantial pension could produce a very different result.

HMRC estimates that around 10,500 estates in 2027/28 could become liable for IHT where they previously would not have been, while around 38,500 estates could pay more IHT than under the previous rules.

The Government’s current estimate is that the average additional IHT liability among affected estates could be around £34,000.

Could an Inherited Pension Really Be Taxed at 67%?

Potentially — but it is important to understand exactly what this means.

This is not a new 67% tax rate.

It arises because two different taxes can potentially apply at different stages.

Imagine £100,000 of pension wealth is fully exposed to Inheritance Tax.

A 40% IHT charge would reduce that £100,000 to:

£60,000

Now suppose the pension owner died after age 75 and the beneficiary is an additional-rate Income Tax payer.

When that beneficiary withdraws the remaining £60,000, a 45% Income Tax charge could amount to:

£27,000

That leaves:

£33,000

from the original £100,000.

In this simplified example:

£67,000 of the original £100,000 has ultimately been lost through the combination of IHT and Income Tax.

Hence the potential 67% effective tax trap.

For a higher-rate taxpayer paying 40% Income Tax on the remaining pension, the equivalent combined effect could be around 64%.

Again, this assumes the pension is fully exposed to IHT in the first place. Real-life calculations depend upon the entire estate, allowances, exemptions, beneficiaries and how benefits are eventually drawn.

But it demonstrates why this change deserves proper attention.

Could the 2027 Pension Changes Affect Your Family?

If you have substantial pension savings and an estate that may already be exposed to Inheritance Tax, the new rules could materially change your existing retirement and inheritance strategy.

Arrange an Inheritance & Pension Planning Review

What Happens if the Pension Owner Dies Before Age 75?

The existing Income Tax treatment of inherited pension benefits remains important.

Broadly, inherited defined contribution pension benefits can potentially be paid free of Income Tax where the pension holder dies before age 75, subject to the relevant pension rules and allowances.

Following death at or after 75, pension benefits withdrawn by beneficiaries are generally taxed as their income.

From April 2027, we therefore need to consider two different tax systems:

Inheritance Tax when assessing the deceased’s estate

and potentially:

Income Tax when beneficiaries subsequently access inherited pension benefits.

That interaction is one of the reasons pension death planning is becoming considerably more important.

Does This Mean Pensions Are No Longer Good for Estate Planning?

Not necessarily.

Pensions remain exceptionally valuable financial-planning vehicles.

They can still offer:

• Income Tax relief on contributions;
• tax-efficient investment growth;
• flexible retirement income;
• tax-free cash subject to the applicable rules;
• potentially attractive death-benefit options;
• long-term investment opportunities.

What is changing is the assumption that:

“My pension should always be the last asset I spend because it is outside my estate.”

For some clients, that has been an extremely effective strategy.

From 2027, it may no longer automatically be the best one.

Should I Start Taking Money Out of My Pension Before 2027?

Not simply because the rules are changing.

Taking large pension withdrawals without proper planning could create an immediate Income Tax bill.

For example, withdrawing money from a pension while still earning a substantial salary could push somebody into a higher tax band.

It may also:

• reduce future retirement income;
• remove money from a tax-efficient pension environment;
• affect future pension contribution allowances;
• leave more money sitting in an estate anyway;
• create investment or longevity risks.

The objective should not be:

“Get everything out of the pension before Labour taxes it.”

It should be:

“Given the new rules, what is now the most tax-efficient way of funding my retirement and ultimately passing wealth to my family?”

Those are very different strategies.

The Order in Which You Spend Your Assets May Need to Change

This could become one of the biggest financial-planning consequences of the reform.

Traditionally, somebody might have been advised to spend:

cash → investments → ISAs → pension last

because the pension enjoyed particularly favourable treatment on death.

From April 2027, that order may deserve reconsideration.

For some clients, drawing more pension income during retirement while preserving other assets could become more attractive.

For others, the opposite may remain appropriate.

And some clients may benefit from a mixture.

There is no universal “correct order”.

But anyone whose retirement strategy was specifically designed around preserving their pension for inheritance should probably have that plan reviewed.

Could Gifting Pension Income Help?

Potentially.

One interesting planning opportunity involves people who are drawing more income than they need to maintain their normal standard of living.

The normal expenditure out of income Inheritance Tax exemption can, where the conditions are met, allow regular gifts to be made from surplus income without the usual seven-year waiting period applying.

Pension withdrawals can constitute income.

This could therefore create circumstances where somebody deliberately draws an appropriate level of taxable pension income and subsequently gifts genuine surplus income to children or other beneficiaries.

However, this is a technical area.

The gifts need to satisfy the rules, be genuinely made from income and leave the donor able to maintain their normal standard of living.

Proper records are extremely important.

Tax advice may be appropriate where this strategy is being considered.

Could an Annuity Become More Attractive?

Potentially — particularly for some older retirees.

An annuity converts some or all of a pension fund into a guaranteed income.

That means the retiree receives an income during their lifetime rather than deliberately retaining a large invested pension pot for beneficiaries.

The new IHT rules could therefore change the balance of the annuity-versus-drawdown decision for some clients.

That does not suddenly make annuities right for everybody.

Important factors include:

• age;
• health;
• annuity rates;
• required income;
• investment risk;
• spouse’s benefits;
• guarantees;
• desire to leave an inheritance;
• other available assets.

But estate planning is now another factor worth adding to that discussion.

Could Life Assurance Be Used to Meet the Inheritance Tax Bill?

Potentially.

For some families, rather than dramatically restructuring investments simply to reduce IHT, it may be possible to insure against part or all of the expected liability.

A suitable whole-of-life assurance policy, normally written under an appropriate trust, could potentially provide beneficiaries with money to help meet an eventual IHT liability.

That doesn’t remove the tax.

Instead, it potentially provides a separate source of funds to help pay it.

Whether that is cost-effective depends heavily on factors such as:

• age;
• health;
• size of the expected liability;
• premiums;
• life expectancy;
• other estate-planning opportunities.

It should therefore be assessed alongside the wider financial plan rather than considered in isolation.

Beneficiary Nominations Still Matter

The new tax rules do not make pension beneficiary nominations irrelevant.

Far from it.

You should still review your expression of wish / beneficiary nomination to ensure it reflects who you actually want to benefit from your pension.

This is particularly important following:

• marriage;
• divorce;
• bereavement;
• births;
• changes to family relationships;
• significant changes in wealth.

Many people completed their pension beneficiary nomination years ago and have never looked at it again.

The forthcoming changes provide a useful prompt to review it.

Should I Leave My Pension to My Spouse Rather Than My Children?

This is going to become a more important planning question.

Transfers between spouses and civil partners can qualify for the IHT spouse exemption.

That could mean pension benefits passing to a surviving spouse avoid an immediate Inheritance Tax charge, whereas benefits passing directly to adult children may form part of the taxable estate.

But simply changing beneficiaries solely to avoid an immediate tax charge may not produce the best overall family outcome.

You need to consider:

• the surviving spouse’s own estate;
• their age and health;
• future IHT exposure;
• the needs of children or grandchildren;
• retirement-income requirements;
• wills and wider estate planning.

This increasingly becomes family financial planning, not simply pension planning.

What Should I Do Before April 2027?

For most people, the answer is not to make an immediate transaction.

It is to review the plan.

I would focus on seven questions:

1. What will my estate actually be worth including pensions?
2. Will I realistically have an Inheritance Tax liability?
3. Who are my pension beneficiaries?
4. Am I deliberately preserving pensions for inheritance?
5. Should the order in which I draw retirement assets change?
6. Could gifting, insurance, annuities or other planning play a role?
7. Does my pension strategy still work alongside my will and wider estate plan?

For people with larger pension pots and estates already approaching IHT thresholds, I would not leave that exercise until April 2027.

Don’t Let the Tax Tail Wag the Investment Dog

This point is particularly important.

Inheritance Tax matters.

But you still need sufficient money to fund the rest of your own life.

You may require funds for:

• normal retirement expenditure;
• holidays;
• replacing cars;
• helping children;
• home improvements;
• later-life care;
• unexpected health costs;
• simply enjoying retirement.

Giving away too much money or dramatically increasing pension withdrawals simply to save future IHT could leave somebody financially worse off.

Your own long-term financial security should come first.

Estate planning should deal efficiently with the wealth you are genuinely unlikely to need.

Why Financial Planning Before 2027 Matters

The forthcoming pension changes demonstrate why financial plans need to evolve.

A strategy that was highly tax-efficient five years ago may not remain optimal when tax legislation changes.

For wealthier retirees in particular, pensions can no longer be considered independently from:

• ISAs;
• investment accounts;
• property;
• cash;
• trusts;
• life assurance;
• gifting;
• wills;
• inheritance planning.

The question is no longer simply:

“How should I invest my pension?”

It is increasingly:

“How should my pension fit into the way I spend, invest and eventually pass on my entire wealth?”

That is a much bigger planning question.

Worried About Inheritance Tax on Your Pension?

If you have built up substantial pension savings and are concerned about how the April 2027 changes could affect your family, Mather & Murray Financial can help you review your position.

We can consider:

• the value of your pensions;
• your wider estate;
• your retirement-income requirements;
• current beneficiary nominations;
• how you are drawing your pension;
• the order in which different assets are being used;
• investment strategy;
• potential gifting;
• protection and life assurance;
• how the pension changes fit into your wider financial plan.

The objective is not simply to minimise tax at all costs.

It is to make sure you have enough money to enjoy your own life while passing wealth to the people you care about as efficiently as reasonably possible.

Arrange an initial conversation with Mather & Murray Financial.

Frequently Asked Questions

Are pensions currently subject to Inheritance Tax?

Most discretionary pension funds currently sit outside the estate for Inheritance Tax. However, this treatment is changing from 6 April 2027 for most unused pension funds and pension death benefits.

When will pensions become subject to Inheritance Tax?

The new rules apply to deaths occurring on or after 6 April 2027.

Will every pension pay 40% Inheritance Tax?

No. IHT depends on the value of the overall estate and the exemptions and allowances available. Many estates will continue to have no IHT liability.

Will my spouse pay Inheritance Tax on my pension?

Transfers to a spouse or civil partner can generally benefit from the normal spouse exemption, subject to individual circumstances.

Will children pay Inheritance Tax on inherited pensions?

Unused pension funds passing to children may contribute to the deceased person’s taxable estate from April 2027. Whether IHT is ultimately payable depends on the entire estate and available allowances and exemptions.

Could beneficiaries pay both Inheritance Tax and Income Tax on a pension?

Potentially. IHT may apply when the pension is included in the deceased’s estate, while beneficiaries can also face Income Tax when withdrawing inherited pension benefits, particularly following death from age 75 onwards.

Is there really a 67% tax on pensions?

There is no standalone 67% pension tax. However, in an extreme simplified example, a pension fully subject to 40% IHT followed by 45% Income Tax on the remaining benefits could leave approximately 33% of the original fund — an effective combined tax burden of around 67%.

Should I withdraw my pension before April 2027?

Not simply because the rules are changing. Pension withdrawals can themselves trigger Income Tax and may reduce your future financial security. Your wider retirement and estate plan should be reviewed before taking action.

Can I give my pension money to my children?

You can potentially withdraw pension income and make gifts, but pension withdrawals may be taxable. Different inheritance-tax gifting rules can then apply depending on the circumstances.

Are death-in-service benefits affected?

Registered pension scheme death-in-service benefits are excluded from the new IHT rules.

What should I do now?

If your estate may face IHT and you hold substantial pension wealth, review your pensions, beneficiary nominations, retirement-income strategy and wider estate planning before April 2027.