Since 2015, pensions have sat outside the scope of Inheritance Tax (IHT), making them one of the most tax-efficient ways to pass on wealth.
However, this is set to change, as pensions will become liable for IHT from April 2027, though the full details have yet to be finalised.
The government estimates the reforms will result in around 10,500 new estates being charged IHT, while around 38,500 will face a higher bill than they would have previously.
With almost 50,000 estates likely to be affected by the changes, it’s a good idea to start planning for IHT mitigation now.
Read on to find out more about what the reforms entail and how you can prepare for them.
The current rules have been in place since 2015
In 2015, the government introduced Pension Freedoms, which provided people with greater flexibility in accessing their pensions and altered the taxation of pensions upon death.
Under the current rules, defined contribution (DC) pensions are generally not considered part of your estate and are typically exempt from IHT. Defined benefit (DB) pensions also usually fall outside the scope of IHT, though this can vary depending on the scheme and provider.
So, most pensions are not liable for IHT, though your beneficiaries may have to pay Income Tax depending on the age you die.
However, these rules are set to change from 2027.
Your pension may be liable for Inheritance Tax under the new system
Under the proposed new system, any remaining pension you have at the time of your death would be treated as part of your estate. This means it could be subject to IHT if it exceeds your nil-rate band, which is the threshold above which IHT is payable.
An important exception remains for death-in-service lump sums, which will continue to sit outside the IHT net.
As pensions are likely one of the largest assets you hold, this change could mean a significant portion of it becomes liable for IHT, potentially reducing the amount you pass on to your beneficiaries.
The current proposal is that the responsibility for reporting and paying any pension-related IHT will fall on the representatives of the estate, rather than the pension scheme administrators, although administrators will still have duties to support the process.
Taking action now can help protect your pension from Inheritance Tax
Reviewing your estate plan ahead of the upcoming changes can help minimise your potential IHT liability and ensure more of your wealth is distributed according to your wishes.
Here are several strategies to consider.
Maximise your nil-rate bands
In 2025/26, the nil-rate bands are as follows:
- Standard nil-rate band is £325,000 – This is the standard threshold above which IHT is due. If your estate is valued higher than this, the excess may be liable for 40% IHT.
- Residence nil-rate band is £175,000 – This is an additional allowance that lets you pass on a further £175,000 IHT-free if you leave your main home to direct descendants.
- Transferable allowances – If you’re married or in a civil partnership, any unused nil-rate bands can be transferred to your surviving partner. This means couples could potentially pass on up to £1 million before IHT is due.
Maximising these allowances can help ensure that IHT on your pension and wider estate is minimised, so you may need to revisit your estate plan to ensure you make full use of them.
Spend more of your pension
One of the simplest ways to reduce the potential IHT liability on your pension is to draw more from it during your lifetime.
A well-planned withdrawal strategy allows you to enjoy more of your savings in retirement while reducing the size of the pension pot that might eventually be subject to IHT.
You can also use withdrawals to support your loved ones or causes close to your heart. For example, you could contribute to a child or grandchild’s pension or Junior ISA, make charitable donations, or gift lump sums.
It’s important to remember that gifts to individuals may still be subject to IHT if you die within seven years, with tax charged on a tapered basis. Withdrawals also need to be tax-efficient and sustainable to protect your long-term financial security.
A financial planner can help you create an efficient withdrawal plan that allows you to use more of your pension while also protecting your long-term security.
Consider Business Relief schemes
Another option is to use your pension to invest in a Business Relief (BR) scheme. If structured correctly, BR can provide up to 100% IHT relief, allowing these assets to be passed on tax-free.
- 100% relief generally applies to a business, an interest in a business, or shares in an unlisted company
- 50% relief can apply to shares controlling more than 50% of voting rights in a listed company, or to land, buildings, or machinery used in a business you owned or controlled, including assets held in a trust you could benefit from.
To qualify, you must have owned the business or asset for at least two years before death.
Because BR investments can be higher risk and the rules are complex, it’s a good idea to speak to a financial planner to ensure the strategy fits your circumstances and is structured correctly.
Use life insurance in trust
You can use some of your pension savings to pay for a life insurance policy held in trust, which keeps it outside your estate for IHT purposes. When you die, the policy typically pays out tax-free and can be used to settle any remaining IHT liabilities.
A financial planner can help determine if this strategy suits your circumstances and ensure it’s structured in the most tax-efficient way.
Get in touch
With the reforms to pensions and IHT set for 2027, now is the time to start planning.
To speak with a financial planner, get in touch.
Email admin@stonegatewealth.co.uk or call us on 01785 876222.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or will writing.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
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