Since the introduction of Pension Freedoms in 2015, pensions have become an effective and efficient way to keep money in the bloodline, largely because unused pension benefits sit outside the Inheritance Tax (IHT) net when passed on.
However, that’s going to change. From April 2027, pensions are set to be brought into the scope of IHT, marking a major shift in how estates are taxed.
As it stands, just over 4% of estates pay IHT, according to the latest data from the UK government. But under the new rules, further government estimates suggest that around 10,500 estates will face IHT for the first time, and a further 38,500 will see bigger bills as a direct result.
So, with around 50,000 estates likely to be affected by the upcoming reforms, now’s the time to work with an independent financial planner to check how the changes could impact your liability and what steps you can take to mitigate them.
Read on to learn more about the changes and what you can do to prepare for them.
Under the new rules, around 10,500 estates will face IHT for the first time
Pensions aren’t currently liable for Inheritance Tax, but this is set to change in 2027
Under the current rules, defined contribution (DC) pensions don’t usually count as part of your estate and are generally exempt from IHT. Defined benefit (DB) pensions are also typically outside the scope, though it varies depending on the provider.
However, your beneficiaries may still need to pay Income Tax on the inherited pension depending on when you pass away. If you die before age 75, your beneficiaries can usually inherit your pension tax-free. If you die after 75, they’ll usually pay Income Tax on anything they withdraw, but crucially, IHT still doesn’t apply.
That’s all set to change in 2027. Under the new system, whatever pension savings you leave behind will be treated as part of your estate.
Once your pension is included with the rest of your assets, it could push your estate above the nil-rate band (currently £325,000), meaning a larger portion may be subject to IHT. On top of that, your beneficiaries could still face Income Tax when withdrawing any unused pension benefits, which means a significant part of it might not end up in their hands.
As pensions are often an estate’s most significant asset (after the family home, which is partly sheltered by the residence nil-rate band), these changes are likely to have a major impact on how much money you can keep in the bloodline.
For many families, this could mean larger IHT bills than expected, so it’s important to rethink how your pension fits into your wider estate plan.
4 ways you can prepare for the upcoming changes and mitigate Inheritance Tax on your pension
With changes to the IHT rules on the horizon, now is a good time to start thinking about strategies that could help reduce your estate’s future liability. An independent financial planner can guide you through the options and develop a bespoke plan to suit your circumstances.
Here are some of the key approaches worth considering.
1. Make the most of your nil-rate bands
In the 2025/26 tax year, the standard nil-rate band – the threshold above which IHT becomes payable – is set at £325,000. On top of this, there’s the residence nil-rate band, which gives you an extra £175,000 allowance if you pass on your main home to direct descendants. Together, these allowances mean you can pass on up to £500,000 in total IHT-free.
If you’re married or in a civil partnership, any unused allowances can transfer to the surviving partner, meaning you could collectively pass on up to £1 million before IHT applies.
Making full use of these allowances is one of the most effective ways to help keep the IHT bill on your estate to a minimum, but it often requires careful financial planning.
2. Use more of your pension while you’re alive
One of the most straightforward ways to limit the impact of IHT on your pension is to use more of it during your lifetime.
By drawing down strategically, you can offer immediate support to your beneficiaries and also reduce the size of the pension pot that could one day be caught by IHT.
This could mean gifting lump sums, paying into a family member’s pension or ISA, or making charitable donations.
It’s important that your withdrawals remain efficient and aligned with your retirement goals. So, it’s a good idea to speak with an independent financial planner to create a structured plan that balances your immediate and longer-term needs.
3. Consider an annuity
An annuity provides you with a guaranteed income in exchange for a lump-sum payment. The income can either be for a set period or for the rest of your life.
By converting pension savings into an income stream, you not only secure a level of certainty in retirement but also reduce the size of your estate that might one day be subject to IHT.
That said, some annuities can continue paying an income to beneficiaries after your death, and in those cases, the payments could still be liable for IHT.
Furthermore, if you were to die soon after purchasing an annuity, you might end up receiving little value compared to what you paid in.
For those reasons, it’s important to carefully consider if an annuity is a good option for you, and if so, which kind. An independent financial planner can explore annuity options with you and determine whether it would fit into your retirement and estate plans.
4. Take out life insurance and put it in trust
Taking out a life insurance policy and putting it in trust removes it from your estate, so the payout goes directly to your beneficiaries. By using your pension to cover the policy premiums, you’re effectively putting that money towards your future beneficiaries IHT-free.
Moreover, when the policy pays out, the money can then be used to help cover the remaining tax bill.
Whole-of-life assurance is often the most effective option here, as it guarantees a payout whenever you die (providing you maintain the premiums), whereas term life insurance will only last for a set period of time.
An independent financial planner can help you weigh up policy and trust options to ensure you have a strategy that works best for your circumstances and those of your beneficiaries.
Get in touch
Tax rules will continue to change, sometimes at short notice, but your long-term goals should remain the guiding principle. An independent financial planner can help you set up a bespoke plan or review your existing arrangements to ensure more of your wealth is used according to your wishes.
To set up an initial appointment with an Amber River financial planner, call 0800 915 0000. Alternatively, you can use our contact form to arrange an appointment.
Disclaimer
The information within this article was correct at the time of publishing, but laws and tax rules are subject to change. Your circumstances and where you live in the UK may also have an impact on your tax treatment.
