Pensions and Inheritance Tax: Planning for the April 2027 Changes

The UK pensions and estate planning landscape is undergoing a fundamental shift. From 6 April 2027, unused pension funds, long considered one of the most tax-efficient ways to pass on wealth, will be brought within the scope of inheritance tax (IHT). This change, announced in the Autumn Budget 2024, marks a significant departure from many years of planning assumptions.

This comes in conjunction with a significant watering down of other IHT reliefs such as agricultural and business relief and this together with the fact that the main IHT allowances have remained unchanged for years will drag many, many more individuals into the IHT trap and require clients and advisers to totally rethink strategy. The relevant Finance Bill formalising these changes is expected to receive royal ascent shortly.

The Current Position (Pre-April 2027)

Under existing rules, most defined contribution pensions sit outside an individual’s estate for IHT purposes. This has made pensions an attractive vehicle for intergenerational wealth transfer.

Key features of the current regime include:

  • Pension funds are typically not subject to IHT on death

  • Benefits can often be passed to beneficiaries tax-efficiently

  • Individuals frequently draw on other assets first, preserving pensions for inheritance

This favourable treatment has led to pensions being increasingly used as a wealth planning tool rather than solely for retirement income which is an issue that HMRC have flagged and a key reason why the government has made this change.

What Is Changing in April 2027?

From 6 April 2027, the government will:

  • Include most unused pension funds and death benefits within the deceased’s estate for IHT purposes  

  • Apply this regardless of whether the scheme is discretionary or not

  • Make personal representatives (executors) responsible for reporting and paying any IHT due

  • Allow pension schemes to withhold funds to cover IHT liabilities

In practical terms, this means pensions will no longer enjoy their longstanding exemption. Instead, they will be treated similarly to other assets such as property and investments.

What Remains Outside the IHT Net?

Not all pension-related benefits will be caught. The following are expected to remain exempt:

  • Death-in-service benefits from registered pension schemes

  • Benefits passing to a spouse or civil partner

  • Payments to registered charities  

These exemptions preserve some important planning opportunities, particularly for married couples.

The Potential Tax Impact – a double or triple tax charge!!

Inheritance tax is generally charged at 40% on assets above the available thresholds (currently £325,000 per person, plus potential residence allowance of up to £175,000)

From April 2027:

  • Pension values will be added to the estate total

  • Many more estates will breach IHT thresholds

  • Beneficiaries may receive significantly less

The reality is that for many, the pension fund is often one of the biggest assets outside of property creating a likelihood of a substantial new tax liability.

These changes have a less obvious sting in the tail in that there is an effective double tax position – after any IHT charge at 40% a client’s beneficiaries would be subject to income tax in drawing the residual funds form the pension assets they have inherited. So, there is a double tax position and for example where beneficiary is a higher rate taxpayer the combined and effective tax rate would be 64%!

In addition, the inclusion of pension assets in estates will inevitably mean that for many the residence nil rate band (RNRB) will be reduced or lost altogether which increases the IHT liability further. The RNRB starts to reduce when an estate exceeds £2m. Thus, for many there is a potential triple tax impact!

Behavioural Changes Already Emerging

Even before implementation, the reforms are changing thinking:

  • Some retirees are drawing down pensions earlier to reduce future IHT exposure  

  • Others are reconsidering annuities or alternative structures

  • Estate planning strategies are being actively revisited

This underscores how significant the shift is in practical terms.

Planning Considerations Ahead of 2027 

With the rules confirmed (subject to final legislation), individuals should begin reviewing their plans now.

Reassessing Drawdown Strategy

The traditional approach of spending non-pension assets first may no longer be optimal. In some cases, it may make sense to:

  • Use pension funds earlier and potentially consider gifts out of income

  • Preserve other assets that may benefit from reliefs or exemptions 

Reviewing Beneficiary Nominations

Although pensions will fall within the estate, death benefit nominations still matter for distribution and administration.

Spousal Planning

Transfers to spouses and civil partners remain exempt from IHT, so:

  • Ensuring efficient spousal structuring is key

  • Married couples can still plan jointly to mitigate tax

Considering all other planning options

With pensions losing their IHT advantage, other strategies are regaining importance: spending and gifting either directly or into trust. Well known mechanisms such as life cover (insure against the liability), loan trusts, discounted gift trusts and family investment companies are coming to the fore. Using assets that are exempt or partially exempt from IHT such as those qualifying for business relief could be valid for some. There is even an increased interest is considering a move abroad to a more favourable tax regime.

Liquidity Planning

Estates may face cash flow challenges if tax is due on pension assets. Executors may need to:

  • Coordinate with pension providers

  • Use mechanisms allowing funds to be withheld to settle IHT

  • Many pension schemes not only hold illiquid assets such as commercial property they have multi-generational family membership all of which requires careful planning.

Conclusion

The inclusion of pensions within the IHT net marks a structural change in how wealth is accumulated, used, and passed on. While the impact will vary depending on individual circumstances, the direction of travel is unmistakable. Those who act early by reviewing withdrawal strategies, beneficiary structures, and overall estate plans will be best positioned to mitigate the effects of the new regime. At Castri WM Ltd we have vast experience in assisting clients with their estate planning needs and our pension specialism means we are well placed to help with these new challenges.

Important information

This communication is for general information purposes and does not constitute advice on investments, legal matters, taxation or any other matters of investment advice.
A pension is a long term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Pension income could also be affected by interest rates at the time benefits are taken.