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Investing
Associate Director
In the Autumn Budget of 2024, Chancellor Rachel Reeves introduced a series of changes to inheritance tax (IHT). While the spotlight fell on adjustments to agricultural property relief—particularly affecting farmers – another reform may have a wider impact. From 6 April 2027, unused pension funds and pension death benefits will be included in a person’s estate for IHT purposes. In short, this means that from that date, there may be inheritance tax payable on pension savings when someone dies.
For years, pensions have offered a valuable shield from IHT and have played a key role in estate planning. Often, they were preserved until last and used to pass wealth down the generations. The government has raised concerns that pensions are increasingly being used for inheritance rather than retirement. Their view is that tax reliefs should support saving for later life – not serve as a tool for passing on wealth.
A consultation followed the announcement, running until the end of January 2025. On 21 July 2025, HMRC published the draft legislation and policy paper, setting out the details of the proposed changes.
Under the current rules, unused pension pots are generally excluded from a person’s estate and are not subject to IHT. These funds can be passed on to chosen beneficiaries. If someone dies before age 75, the pension can be transferred tax-free – either as a lump sum, drawdown, or annuity- provided it falls within the Lump Sum & Death Benefit Allowance and is claimed within two years of notifying the pension scheme. If death occurs at age 75 or older, the pension is subject to income tax at the recipient’s marginal rate, but still not liable for IHT.
From April 2027, however, things will change. Unused defined contribution pensions will be included in the estate when calculating IHT. Any value above the available allowances—£325,000 (nil-rate band), £175,000 (residence nil-rate band), and any exempt gifts or transfers—will be taxed at 40%. The responsibility for reporting and paying the tax will fall to the deceased’s personal representatives.
The pensions affected are mainly defined contribution schemes. These are arrangements where people and their employers contribute to a pension pot, which is invested in assets like equities and bonds. The retirement income depends on the size of the pot and how well the investments perform. In contrast, defined benefit or final salary pensions are largely unaffected. These schemes provide a guaranteed income for life based on salary and years of service, and don’t involve a transferable pot.
Government estimates suggest that around 10,500 estates will become liable for IHT for the first time due to these changes, with a further 38,500 estates expected to pay more tax.
Despite the reforms, pensions remain one of the most tax-efficient ways to save for the long term. There are several strategies people can consider to reduce the impact of IHT, though it’s important to remember that there’s no one-size-fits-all solution. Everyone’s financial situation is different, and any planning should begin with a clear understanding of personal priorities—especially the need for retirement security.
For married couples in the UK, assets passed to a surviving spouse are exempt from IHT. Unused nil-rate and residence nil-rate bands can also be transferred to the surviving spouse, meaning a couple could potentially pass on up to £1 million to direct descendants without incurring any inheritance tax.
When it comes to mitigation, some people choose to accept the potential tax liability and take no action. For those who do want to reduce their exposure, one of the simplest approaches is to spend the money—after all, that’s what it’s there for. Just be careful not to convert cash into more taxable assets, which could make the IHT problem worse.
Another option is gifting. If someone lives for seven years after making a gift, the value is excluded from their estate. Gifts can be made directly to people, charities, or via trusts, which can help protect assets from misuse or divorce. That said, gifting should be done thoughtfully to avoid creating tax issues for the next generation.
Finally, for those who aren’t able or willing to spend or gift their pension savings, life assurance can offer a practical solution. A policy written in trust can provide a lump sum upon death, which sits outside the estate and can be used by executors to pay the IHT bill.
In summary, the inclusion of unused pensions in the IHT net marks a significant shift in estate planning. While it introduces new challenges, it also highlights the importance of proactive financial planning. With the right advice and a clear understanding of personal goals, people can still make the most of their pension savings – both for their retirement and for the legacy they want to leave behind.
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If you’re unsure how these changes affect your pension or your estate, please contact us to arrange a chat and a personalised review with one of our advisers.
This blog post is intended for information only and does not represent personal financial advice. Past performance is not a guide to future performance. The value of an investment can fall as well as rise and is not guaranteed – you may get back less than you paid in.