Pension Inheritance Tax Changes Explained (2027)
For many years, retirement and estate planning followed a broadly accepted order:
Spend cash first.
Use ISAs and other investments where necessary.
Preserve the pension for as long as possible.
That approach was often entirely rational. Defined contribution pension funds could normally continue growing in a tax-advantaged environment and, where the scheme operated on a discretionary basis, unused funds would generally sit outside the member’s estate for Inheritance Tax purposes.
From 6 April 2027, that position changes fundamentally.
For deaths occurring on or after that date, most unused pension funds and pension death benefits will be brought into the deceased member’s estate for Inheritance Tax purposes. The legislation was enacted through Finance Act 2026, although further regulations and detailed HMRC guidance are still being developed ahead of implementation. (GOV.UK)
This is not simply another tax amendment.
It changes how families should think about retirement income, beneficiary nominations, lifetime gifting, property wealth, trusts, Wills and the administration of the estate itself.
What is actually changing?
The new rules will apply primarily to unused defined contribution pension funds, together with certain other pension death benefits.
The fact that pension trustees retain discretion over who receives the pension will no longer, by itself, keep the fund outside the estate. The legislation will instead treat the deceased as beneficially entitled to the relevant pension value immediately before death.
There are important exceptions.
Death-in-service benefits paid from registered pension schemes will remain outside the scope of Inheritance Tax. Certain continuing annuities and other specifically excluded benefits may also fall outside the new regime.
Payments passing to an exempt beneficiary, most notably a qualifying spouse or civil partner, should continue to benefit from the normal spouse exemption. However, the full pension value must still be identified and reported before the relevant exemption is applied. (GOV.UK)
That distinction matters.
Passing a pension to a spouse may defer the tax problem, but it does not necessarily remove it. The pension wealth may simply become part of the surviving spouse’s own eventual estate.
How many families will be affected?
HMRC estimates that approximately 213,000 estates will contain inheritable pension wealth during 2027–28.
Of those, around:
10,500 estates are expected to become liable for Inheritance Tax when they would not otherwise have paid it; and
38,500 estates are expected to pay more Inheritance Tax than under the previous rules.
HMRC has described those figures as an upper estimate because they do not account for families changing their behaviour before the rules take effect. (GOV.UK)
The number of affected estates is significant, but the wider importance of the change goes beyond those immediately paying tax.
Many more families will need pension valuations, beneficiary information and additional communication between executors, pension providers, trustees and advisers before it can be established that no tax is due.
Frozen allowances make the problem larger
The ordinary Inheritance Tax nil-rate band remains fixed at £325,000.
The residence nil-rate band remains fixed at £175,000, where the qualifying conditions are satisfied, and begins to taper once the estate exceeds £2 million.
These thresholds are now due to remain frozen until 5 April 2031. (GOV.UK)
As asset values and pension funds continue to grow, the practical value of those allowances continues to decline.
Including a pension within the estate may therefore create two separate problems.
First, the pension itself may become taxable.
Secondly, it may push the total estate above £2 million and begin reducing the residence nil-rate band by £1 for every £2 of excess value.
A simplified example
Consider a surviving spouse who owns:
a home worth £900,000;
savings and investments worth £400,000; and
an unused defined contribution pension worth £800,000.
The total estate, including the pension, is £2.1 million.
Assuming the estate qualifies for the full transferred nil-rate bands, passes the home to direct descendants, and has no relevant debts, gifts or other reliefs, the £2.1 million estate would exceed the residence nil-rate band taper threshold by £100,000.
That would reduce the combined residence nil-rate band from £350,000 to £300,000.
The simplified Inheritance Tax calculation would therefore be approximately:
Estate: £2,100,000
Less combined nil-rate bands: £650,000
Less tapered residence nil-rate band: £300,000
Taxable estate: £1,150,000
Inheritance Tax at 40%:£460,000
Under the former treatment, if the £800,000 pension remained outside the estate, the chargeable estate would have been £1.3 million.
On the same simplified assumptions, the resulting Inheritance Tax would have been approximately £120,000.
The difference is £340,000.
This example is deliberately simplified, but it illustrates why the change cannot be treated merely as a technical adjustment to the probate forms.
The traditional withdrawal order may no longer be appropriate
The old assumption that the pension should always be the last asset spent is no longer safe.
But the opposite approach—drawing the pension down as quickly as possible—would be equally crude.
Pension withdrawals may create an immediate Income Tax liability. They may affect entitlement to allowances, increase the tax rate applied to other income and reduce the period during which capital can continue growing within the pension environment.
The proper question is no longer:
“How do we preserve the pension?”
It is:
“Which assets should be retained, spent, gifted or transferred, and in what order, to produce the best overall result during life and on death?”
That calculation should consider:
the pension holder’s expected expenditure;
available secure income;
future care requirements;
Income Tax rates;
the likely size of the estate;
the age and tax position of intended beneficiaries;
property wealth;
gifting objectives; and
the family’s need for access and control.
The answer will differ from one family to another.
Income Tax has not disappeared
The Inheritance Tax change does not replace the existing Income Tax rules applying to inherited pensions.
Broadly, where the pension holder dies before age 75, many inherited pension benefits can currently be received without Income Tax, subject to the applicable conditions and allowances.
Where the pension holder dies aged 75 or over, pension benefits drawn by the beneficiary will generally be subject to Income Tax at the beneficiary’s applicable rate. (GOV.UK)
It is therefore possible for a pension to contribute towards an Inheritance Tax liability and for the remaining benefits subsequently drawn by the beneficiary to be subject to Income Tax.
HMRC has introduced mechanisms intended to prevent Income Tax being charged on the portion of pension benefits used directly to meet the Inheritance Tax attributable to that pension. Nevertheless, the combined tax exposure on the overall inherited pension may still be substantial. (GOV.UK)
This is why isolated pension advice is no longer enough. The pension, estate and beneficiary tax positions must be considered together.
The surviving spouse must not be treated as an afterthought
For married couples and civil partners, the first death may still produce little or no immediate Inheritance Tax because of the spouse exemption.
That can create a false sense of security.
Where pension benefits, property and investments pass to the survivor, the surviving spouse may inherit a much larger estate than either partner owned independently.
The crucial planning point may therefore arise immediately after the first death.
At that stage, the surviving spouse’s position should be reviewed afresh, including:
the level of pension wealth inherited;
the survivor’s own pension provision;
the combined value of property and investments;
existing gifts;
the terms of the Will;
beneficiary nominations;
trust arrangements; and
the likely position on the survivor’s eventual death.
A plan designed when both spouses were alive cannot simply be left untouched after one of them dies.
Estate planning is not a document. It is a continuing process.
Pension nominations now carry even greater importance
A Will does not ordinarily determine who receives benefits from a discretionary pension scheme.
The pension provider or pension trustees will consider the member’s expression of wishes, the scheme rules and the potential beneficiaries before making their decision. (GOV.UK)
That means the Will, pension nomination and wider estate plan must be coordinated.
A nomination that was sensible five years ago may now produce an unnecessarily poor result.
For example, nominating a spouse may secure spouse exemption on the first death but concentrate the entire family wealth in the survivor’s estate.
Nominating adult children may avoid that concentration but expose the pension to immediate Inheritance Tax and, depending upon the deceased’s age, possible Income Tax when the beneficiaries draw the funds.
There is no universally correct nomination.
There is only a nomination that is correct for the particular family, supported by current valuations and reviewed as circumstances change.
Lifetime gifting will become more important—but records will be essential
Some families may decide to draw pension income or capital during life and make gifts to children, grandchildren or other intended beneficiaries.
That may form part of legitimate estate planning, but it must be structured carefully.
Outright gifts to individuals may fall outside the estate where the donor survives for seven years. Regular gifts made from surplus income may also qualify for the normal expenditure out of income exemption where they form part of a settled pattern, are genuinely made from income and leave the donor able to maintain their normal standard of living. (GOV.UK)
The phrase “made from surplus income” is important.
Simply withdrawing a large capital sum from a pension and describing the resulting gift as being made from income will not automatically satisfy the exemption.
The source, regularity, affordability and pattern of the gifts must be capable of being demonstrated.
Bank statements, pension statements, income and expenditure records, written gifting intentions and annual reviews may become as important as the gift itself.
HMRC cannot be expected to reconstruct an undocumented family arrangement several years after the donor has died.
Trust planning must have a genuine purpose
Trusts may continue to play an important role in controlling how wealth is received, protecting vulnerable beneficiaries, managing succession and preventing an inheritance passing outright into unsuitable hands.
However, a trust should not be presented as a convenient way of making the pension change disappear.
Transfers into trust can carry immediate Inheritance Tax consequences, ongoing reporting requirements, periodic charges and other tax considerations. The trust must have a clearly documented family or succession purpose and be appropriate for the assets and beneficiaries concerned. (GOV.UK)
Good drafting remains essential, but drafting alone is not planning.
The trust, pension nominations, Will, letters of wishes and lifetime financial strategy must all point in the same direction.
Property wealth must be considered—but equity release is not automatically the answer
The inclusion of pension wealth may lead some advisers to focus more heavily on the family home and later-life lending.
That may be appropriate in some cases, particularly where a client is property-rich but has limited accessible cash.
However, releasing equity does not, by itself, reduce the taxable estate.
It converts part of the property value into cash and creates a debt carrying interest. The estate-planning effect depends upon what is then done with the money.
Where released funds are retained in a bank account, the estate may simply contain cash instead of equity.
Where the funds are spent or gifted as part of a properly considered plan, there may be a genuine estate-planning effect—but the interest cost, seven-year risk, affordability, care needs and security of the homeowner must all be considered.
Later-life lending is a financial product, not an Inheritance Tax strategy in its own right.
Estate administration will become more complicated
From April 2027, personal representatives will be responsible for reporting and paying the Inheritance Tax attributable to pension wealth.
Once pension benefits become vested in a beneficiary, that beneficiary may also become jointly and severally liable for the tax attributable to those benefits.
Pension providers will be required to supply valuation and beneficiary information. Where the personal representatives reasonably believe that Inheritance Tax may be due, they may be able to require the pension scheme to withhold up to 50% of affected benefits for a limited period.
Inheritance Tax will remain due by the end of the sixth month following the death, after which interest may arise. (GOV.UK)
Executors will therefore need to identify every pension arrangement, obtain accurate date-of-death valuations, establish the destination of the benefits and coordinate payment of the tax.
Families should begin making that task easier now.
A current schedule of pension providers, policy numbers, nominated beneficiaries and professional contacts should be kept with the estate-planning records.
The pension itself may pass outside probate, but it will no longer sit outside the Inheritance Tax calculation.
What should clients be doing now?
The starting point is not to withdraw pensions indiscriminately or rewrite every nomination in favour of the spouse or children.
The starting point is a proper review.
That review should establish:
the projected value of the entire estate, including pension wealth;
whether the pension could push the estate above the ordinary or residence nil-rate bands;
whether the estate may exceed the £2 million residence nil-rate band taper threshold;
whether existing pension nominations remain appropriate;
whether the current order of pension and investment withdrawals remains efficient;
whether regular lifetime gifting is affordable and properly documented;
whether the Will and any trusts remain aligned with the pension strategy; and
whether the executors will have sufficient information and liquidity to administer the estate.
The families most exposed are not necessarily only the obviously wealthy.
A homeowner with a valuable property, moderate investments and a pension accumulated over several decades may now find themselves within the Inheritance Tax regime for the first time.
The wider lesson
Pensions were designed to provide retirement income.
Over time, tax policy also made them highly effective vehicles for transferring wealth between generations.
The government has now deliberately changed that balance.
From April 2027, pensions cannot be treated as a separate island sitting outside the family’s estate plan.
They must be considered alongside property, investments, lifetime gifts, Wills, trusts, beneficiary protection and the needs of the surviving spouse.
At iTrust121, our view is that this change reinforces a principle that should already sit at the heart of good estate planning:
A plan must evolve with the law, the assets and the family.
Anything else is not a plan.
It is merely a set of documents waiting to become outdated.
Author
James Berkeley
Senior Counsel | iTrust121
This article is provided for general information and does not constitute individual legal, tax or regulated financial advice.