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For years, the pension has quietly done double duty, funding your retirement and sheltering wealth from inheritance tax. From April 2027, that second role disappears. Here’s what it means, and what to do about it now.
Why this matters right now
If you have ever been told, or assumed, that leaving money inside your pension is one of the smartest things you can do for your family, you were given perfectly good advice. For the better part of two decades, that was exactly right.
Defined contribution pensions held on a discretionary basis sit outside your estate for inheritance tax purposes. Die before 75, and the pot could pass tax-free. Die after 75, and beneficiaries paid only income tax, at their own marginal rate — no inheritance tax at all. It made the pension the single most tax-efficient way to pass wealth to the next generation.
That changes on 6 April 2027. From that date, most unused pension funds and lump-sum death benefits will be pulled into your estate and valued for inheritance tax. For many families, this isn’t a tweak. It’s a fundamental rethink.
The key shift
Unused pension pots will now count as part of your estate. Above the available nil-rate bands, inheritance tax at 40% will apply, and for deaths after age 75, beneficiaries may also face income tax on top. In some cases, the combined tax drag could swallow over half the pension’s value.
What’s actually changing
It’s worth being precise here, because the headlines can make it sound like pensions are being taxed entirely differently. The reality is more specific, and the details matter.
What’s included
Unused funds in defined contribution (money purchase) pensions, drawdown pots, and most lump-sum death benefits from registered schemes will all form part of your estate.
Death-in-service benefits paid from a registered pension scheme are excluded, a concession made by the government following industry feedback. Defined benefit survivor pensions are also excluded.
The inheritance tax spousal exemption still applies in the normal way. Assets left to a spouse or civil partner remain free of inheritance tax on the first death. This is an important planning point we’ll return to below.
The double tax problem
This is where the change gets uncomfortable. Under the new rules, if you die aged 75 or over, your beneficiaries could face both inheritance tax on the estate and income tax when they actually draw the pension funds. This is sometimes called the “double taxation” risk, and it’s the reason financial planners are taking this change so seriously.
To put numbers to it, consider a straightforward example:
|
Scenario |
Estate Value |
Pension Portion |
Potential Tax Outcome |
|
Estate below nil-rate bands |
£500,000 |
£200,000 |
No IHT due. Income tax may apply to the pension if death occurs after age 75. |
|
Estate above nil-rate bands |
£1,000,000 |
£500,000 |
IHT applies to the excess. The pension’s share of IHT is paid from the pot first, then income tax applies on top when beneficiaries draw funds (if death after 75). |
|
Pension passed to spouse first |
£1,000,000 |
£500,000 |
Spousal exemption means no IHT on the first death. Planning opportunity on the second death. |
The nil-rate band remains frozen at £325,000, and the residence nil-rate band at £175,000 for direct descendants. With property values continuing to rise, more estates will drift into the taxable zone even without any active change.
What this means for your planning
The old playbook, “maximise pension contributions, leave as much as possible untouched, let it pass to your children”, needs revisiting. That doesn’t mean pensions are no longer valuable. They absolutely are, both for tax relief going in and for funding your own retirement. But the strategy around when you draw from them, and what else you hold alongside them, needs to change.
Here are the questions worth asking yourself now, well ahead of the April 2027 deadline:
1. Review your death benefit nominations
Who is named on your expression of wishes form? Under the new rules, it may be more tax-efficient to nominate a spouse or civil partner first, using the spousal exemption to defer the IHT question rather than passing directly to children. If your nomination hasn’t been reviewed in years, now is the time.
2. Think about drawing earlier
If your pension is significantly larger than you need for your own retirement income, drawing funds earlier and moving them into an ISA or using them for gifts may now be more tax-efficient than leaving them untouched. This is a shift in thinking for many people.
3. Consider your tax-free cash
If you have deferred taking your tax-free lump sum, revisit that decision. Once withdrawn, that cash is outside the pension and only subject to IHT, not the potential double-tax hit. For those over 75, this distinction is particularly important.
4. Look at the wider estate picture
Pensions, ISAs, property, investments, and any gifts you’ve made all interact. A plan that looked sensible last year may need adjusting in light of this change. This is where proper, holistic financial planning earns its keep.
5. Explore regular gifting from income
If you have surplus pension income, gifts made regularly out of income that don’t reduce your standard of living are immediately exempt from inheritance tax. Drawing pension income specifically to fund these gifts is now a strategy worth serious consideration.
What pensions still do well
It would be easy to read all of this and conclude that pensions are somehow less useful than they used to be. In one narrow sense, as a pure wealth transfer vehicle, that’s true. But in every other sense, pensions remain one of the most powerful financial tools available.
Tax relief on contributions going in is unchanged. The tax-free growth on investments inside a pension is unchanged. The ability to take 25% of your pot tax-free at retirement is unchanged. Pensions are still the most tax-efficient way to save for your own retirement. The change is specifically about what happens to the money after you die, and only where the estate is large enough to be taxable.
The shift is not away from pensions. It’s towards a more balanced approach, one where pensions sit alongside ISAs, investments, and careful lifetime planning, rather than carrying the entire weight of both retirement income and legacy.
The bottom line
April 2027 is still over a year away, but the planning decisions that will matter most need to happen well before then. Nomination forms need updating. Drawdown strategies need revisiting. And for anyone who has been relying on the pension as their primary estate planning tool, a broader conversation about the shape of their financial future is overdue.
This isn’t about panic. It’s about being informed and being early. The people who will be best placed when these rules land are the ones who start thinking now, not the ones who wait until the headlines get louder.
Is your pension plan still fit for purpose?
If you haven’t reviewed your pension nominations or estate strategy recently, it might be time for a fresh look. A short conversation can clarify a lot.
This article is for general information purposes only and does not constitute personal financial, tax, or legal advice. The tax treatment of pensions and estates depends on your individual circumstances, and the rules described here are based on current legislation and proposals, which may change.
