For many years, pensions have played a central role in estate planning. Their favourable tax treatment meant they could often be passed on to loved ones with little or no Inheritance Tax (IHT), making them one of the most effective tools for intergenerational wealth transfer.
However, upcoming changes announced in the 2024 Budget will fundamentally alter how pensions are treated for IHT purposes. From April 2027, unused defined contribution pension funds will no longer sit outside the estate for IHT calculations. This change has significant implications for individuals, couples, and families planning their financial legacy.
How pensions have traditionally been treated
Historically, pensions benefited from special tax treatment on death:
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If you died before age 75, beneficiaries could usually receive remaining pension funds tax-free
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If you died after age 75, pension funds were taxed at the beneficiary’s marginal income tax rate, rather than IHT
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Crucially, pension pots were excluded from the estate for IHT purposes
This meant many people deliberately spent other assets first—such as cash savings, ISAs, and investments—while preserving pensions as a tax-efficient inheritance.
What is changing from April 2027?
From 6 April 2027, unused defined contribution pension funds and death benefits will be included in the value of your estate when calculating IHT.
This means:
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Pension funds could be taxed at up to 40%
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More estates will exceed the £325,000 nil-rate band
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Pensions will be treated much like other assets, such as property or investments
While pension tax relief and tax-free cash rules remain unchanged, the inclusion of pensions within the IHT framework represents a major shift in long-term planning.
Understanding the wider IHT landscape
Inheritance Tax is charged on the value of an individual’s estate above the nil-rate band, currently £325,000. This threshold has been frozen until April 2031, which means more families are gradually being pulled into the tax net due to rising asset values—a process often referred to as fiscal drag.
Including pensions in the estate will accelerate this trend, increasing the likelihood that beneficiaries face significant tax bills.
Who is most affected by the changes?
Married couples and civil partners
The spousal exemption remains in place. This means:
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Assets (including pensions) can still be passed to a spouse or registered civil partner free of IHT
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With careful planning, IHT can often be deferred until the death of the second partner
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Combined nil-rate bands may help reduce the overall tax liability
Unmarried partners
Unmarried partners face significantly greater exposure:
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They do not benefit from the spousal exemption
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Pension funds left to them will be added to the taxable estate
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If this exceeds £325,000, the inherited pension could be taxed at up to 40%
Many couples underestimate this risk, particularly where most wealth is held within pensions.
Children and other beneficiaries
Pensions passed to children or other beneficiaries will also be included in the estate value, potentially:
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Triggering an IHT liability where none previously existed
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Increasing an existing IHT bill
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Reducing the effectiveness of pensions as a legacy-planning tool
Administrative changes to be aware of
Under the new rules, Pension Scheme Administrators (PSAs) will be responsible for:
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Reporting unused pension funds to HMRC
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Paying any IHT due before distributing funds to beneficiaries
This adds an extra administrative layer at an already difficult time and may delay access to funds. Keeping documentation up to date and ensuring pension providers have clear instructions will be increasingly important.
Rethinking retirement and withdrawal strategies
The long-held strategy of “spend other assets first, preserve the pension” may no longer be optimal.
From 2027:
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Both pensions and ISAs will be included in the estate for IHT
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Retirees may consider drawing pensions earlier to enjoy wealth during their lifetime
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Pension withdrawals could be used to fund lifetime gifting, potentially reducing the taxable estate
Balancing withdrawals across pensions, ISAs, and other assets will require a more nuanced, tax-aware approach.
Lifetime gifting and alternative planning options
In light of the new rules, families may wish to explore:
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Lifetime gifts, which can fall outside the estate if made more than seven years before death
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Annual gifting allowances and gifts from surplus income
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Trusts, insurance policies, or other bespoke estate-planning tools
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Assets that qualify for IHT relief, such as certain business or agricultural property
For many, it may be more effective to pass on wealth during their lifetime rather than relying on pension inheritance.
Practical steps you can take now
To prepare for the changes, consider the following actions:
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Review expression of wish forms with all pension providers
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Reassess beneficiary nominations in light of your wider estate plan
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Evaluate gifting strategies, keeping accurate records
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Use available allowances, including annual and small gift exemptions
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Review the order of asset withdrawals in retirement
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Check pension scheme guarantees before making changes
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Explore trusts or insurance solutions where appropriate
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Keep detailed records of pensions, gifts, and nominations
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Seek professional advice to develop a tailored, long-term strategy
Conclusion
Including pensions within the scope of Inheritance Tax marks a significant shift in financial planning. What was once one of the most effective ways to pass wealth to future generations will soon be treated like any other taxable asset.
Although these changes do not take effect until April 2027, the transition period offers a valuable opportunity to act. Early, well-structured planning can help reduce tax exposure, protect beneficiaries, and ensure your legacy is passed on in line with your wishes.
