Will My Pension Be Subject to Inheritance Tax?
Understanding the current rules, proposed reforms, and what they could mean for estate planning.
For many years pensions have been one of the most tax‑efficient ways to pass wealth to the next generation. However, proposed reforms suggest that unused pension funds may soon be included within the scope of inheritance tax (IHT).
This article explains the current rules, explores the potential changes expected from April 2027, and examines the implications for estate planning and retirement strategy.
Section 1 – Current Rules: How Pensions are treated for Inheritance Tax
Under current UK legislation, most pension funds are not included in the value of a deceased person’s estate for inheritance tax purposes. This favourable treatment arises primarily because pension schemes are normally established under trust arrangements. Instead of the member directly owning the underlying assets, trustees or scheme administrators hold the pension funds and retain discretion over how death benefits are paid.
Because the member does not technically control the distribution of those funds at the point of death, the pension pot is generally not treated as part of their estate. This structure has made pensions one of the most powerful tools in modern estate planning.
Trustees and Beneficiaries
Most occupational pension schemes operate through a trust deed and scheme rules. These documents give trustees the power to decide who should receive death benefits from a defined group of potential beneficiaries.
Typical beneficiaries include:
• A spouse or civil partner
• Children or other dependents
• Other family members
• Individuals nominated by the pension member
Members can submit an “expression of wishes” form indicating who they would prefer to receive the benefits. Although trustees normally take this into account, it is not legally binding. The discretionary nature of the payment is a key reason pension benefits are normally excluded from the estate.
Income Tax Treatment
While pensions usually avoid inheritance tax under the current rules, income tax can still apply depending on the age of the member when they die.
If death occurs before age 75, pension benefits can usually be paid to beneficiaries free of income tax provided they are paid within two years.
If death occurs after age 75, withdrawals from inherited pensions are typically taxed at the beneficiary’s marginal income tax rate.
Inherited Pension Drawdown of Benefits
Beneficiaries do not necessarily have to withdraw the entire pension immediately. They may instead keep the funds invested within a pension wrapper through inherited drawdown.
This allows the remaining funds to stay invested and potentially grow further. However, once the money is withdrawn and held outside the pension environment it becomes part of the beneficiary’s own estate and may be subject to inheritance tax when they die.
Section 2 – Proposed Changes: Pensions and IHT from 2027
Government policy announcements connected with recent Budget reforms indicate that unused pension funds and certain death benefits could be brought within the scope of inheritance tax from 6 April 2027.
If implemented, this would represent one of the most significant changes to pension taxation in decades.
Under the proposed system, unused pension funds could be added to the value of the deceased person’s estate when calculating inheritance tax.
Inheritance tax currently applies at 40% on the portion of an estate above the available allowances. These allowances include:
• The £325,000 Nil Rate Band
• The Residence Nil Rate Band of up to £175,000
• Transferable allowances between spouses
Including pension funds within the estate calculation could therefore push some estates above these thresholds and create additional tax liabilities.
Responsibility for Reporting
Another major feature of the proposed reforms concerns who will be responsible for calculating and paying inheritance tax on pension assets.
Under the proposals, Personal Representatives (PRs) — the individuals responsible for administering the estate — may need to report pension assets and ensure the correct inheritance tax is paid.
This creates complexity because pension assets are usually held by pension scheme administrators rather than by the estate itself.
PRs may therefore need to gather information from pension providers about:
• Pension fund values
• Beneficiaries
• Death benefit structures
Policy Concerns
Policy reviews have highlighted several practical challenges, including:
• Administrative complexity for families
• Delays in obtaining pension valuations
• Difficulty meeting the six‑month inheritance tax payment deadline
Possible adjustments being discussed include longer deadlines for paying tax and improved data sharing between pension schemes and estate administrators.
Section 3 – Possible Implications
Reconsidering Retirement Strategies
For many years financial advisers have suggested that retirees draw income from other investments first while leaving their pension invested as long as possible.
This strategy allowed pension funds to grow outside the estate and eventually pass tax efficiently to beneficiaries.
If pensions become subject to inheritance tax this strategy may change. Individuals may decide to withdraw pension funds earlier during retirement or rebalance their assets.
Administrative Complexity
One of the most significant implications of the reforms is the additional burden placed on personal representatives. Many PRs are family members with limited experience of tax administration.
Including pensions within the inheritance tax calculation could increase the need for professional advice and raise the cost of estate administration.
Liquidity Issues
Inheritance tax normally needs to be paid within six months of death. Pension assets may not always be accessible during that timeframe.
If pension values are included in the estate but cannot easily be withdrawn, estates may face liquidity challenges. Personal representatives may need to coordinate with pension providers or use other assets to cover the tax bill.
Behavioural Changes
Tax changes often influence financial behaviour. If pensions lose some of their inheritance tax advantages individuals may alter their retirement planning strategies.
Possible responses could include:
• Earlier pension withdrawals
• Increased lifetime gifting
• Greater emphasis on retirement income planning
Despite these potential changes pensions will remain attractive because of their income tax relief on contributions and tax‑efficient investment growth.
Conclusion
Pensions have historically benefited from favourable inheritance tax treatment because they sit outside the taxable estate. This has made them a powerful vehicle for transferring wealth across generations.
However, proposals expected to take effect from April 2027 could bring unused pension funds into the inheritance tax calculation.
While the final legislation is still evolving, individuals may wish to review their estate planning strategies, update beneficiary nominations, and seek professional advice.
Timely financial planning remains the most effective way to ensure wealth is passed on efficiently while managing potential tax liabilities.