Pensions and inheritance tax changes 2025: What you need to know

At the moment, pensions enjoy more favourable inheritance tax rules than most other types of assets. The way they’re taxed depends largely on how old you are when you die, and how your pension scheme is set up.

Here’s a quick breakdown:

• If you die before age 75: Any money left in your defined-contribution pension can usually be passed on completely tax-free. That includes lump sums or regular withdrawals, provided the funds are paid out within two years.
• If you die at 75 or older: Your beneficiaries can still inherit your pension, but they’ll pay income tax on anything they withdraw, at their usual tax rate (20%, 40%, or 45%). However, no inheritance tax is due under the current rules.

This makes pensions a valuable estate planning tool, especially for those who don’t need to draw down all their pension during their lifetime.

From 6 April 2027, under proposals announced by Rachel Reeves, any unused pension savings and death benefits will be included in your estate for inheritance tax purposes, regardless of your age at death.

So even if you pass away before age 75, and even if your beneficiaries act quickly, the value of any remaining pension funds will count towards your estate, and could be taxed at up to 40% under IHT rules.
The government estimates this will affect around 8% of estates each year, and is primarily targeted at those with larger pension pots that they haven’t needed to draw down during retirement.

• The current rules are seen as offering an unintended tax advantage, especially to wealthier households using pensions to pass on wealth.
• The new rules are designed to make the system fairer and more consistent, aligning pensions with how other assets are taxed on death.
• The change is also expected to generate additional tax revenue to support public services.

Let’s say someone passes away with a significant pension pot that hasn’t been used.

Right now, if they’re under 75, that money can usually be passed on tax-free. But under the new rules, even if they’re under 75, the pension may be taxed in two ways:

• Inheritance Tax at up to 40%, based on the total value of their estate
• Income Tax when the beneficiary makes withdrawals from the inherited pension

That’s a substantial reduction in the value of what might be passed on to loved ones.

Not immediately. These changes are still being finalised and won’t take effect until April 2027. But if your pension forms part of your legacy plans, it’s a good time to review your strategy and make sure you’re on the right path.

A financial planner can help you understand the impact of the changes and explore your options, from tax-efficient withdrawals to rebalancing your income strategy or considering other ways to support your family financially.