IHT on Pensions from April 2027: What You Need to Know Now

A Generation of IHT-Free Pensions Is Ending

Since the pension freedoms introduced in April 2015, defined contribution pension funds have been one of the most powerful tools in estate planning. By leaving a pension pot untouched and drawing on other assets first, wealthy households could pass on substantial sums entirely free of inheritance tax. Pension funds sat outside the estate; scheme trustees used discretionary nomination forms to pay proceeds directly to beneficiaries without ever entering the taxable estate. For many people with large pensions, this arrangement dramatically reduced or eliminated their IHT liability.

That position will change fundamentally on 6 April 2027. The Government announced in the October 2024 Autumn Budget that unused pension funds and lump sum death benefits will be brought within the scope of inheritance tax. Subsequent Finance Bill consultations have confirmed the measure and provided more detail on implementation. For anyone with a defined contribution pension — and particularly for those whose estate already exceeds or approaches the nil-rate band thresholds — this is one of the most significant estate planning changes in a generation.

The Current Position: Pensions Outside the Estate

Under the rules in force until 5 April 2027, defined contribution pension pots do not form part of your estate for IHT purposes when you die. Instead, the funds remain held within the pension scheme and the trustees or scheme administrators have discretion over who receives the death benefits. Provided the nomination form is completed correctly and kept up to date, the trustees will typically pay in accordance with your wishes, but the funds are theirs to direct — not yours — and this discretionary nature is what keeps them outside your estate.

This means the entire pension pot — regardless of its size — can be passed on completely free of inheritance tax. A pot of £1 million would pass to children or grandchildren without a penny of the 40% death tax applying. For this reason, financial planners have increasingly recommended that clients spend other assets first and preserve their pension as an inheritance vehicle.

The New Position from April 2027: Inside the Estate

From 6 April 2027, the value of unused pension funds and the value of lump sum death benefits will be added to the rest of your estate when calculating the IHT liability on death. The practical implication is that pension scheme administrators will for the first time become responsible for reporting the pension value to HMRC and paying the IHT attributable to the pension portion of the estate.

The mechanics of how administrators pay the IHT charge — and how the proceeds available to beneficiaries are then reduced accordingly — are being worked through in the ongoing consultation. The headline effect, however, is clear: a pension pot that was previously IHT-free will now potentially face a 40% tax charge on the portion above available nil-rate bands.

Illustrating the Impact

The table below shows the IHT effect on an example estate before and after April 2027.

Scenario A: Surviving spouse, property passes to children on second death, RNRB available

Standard nil-rate band: £325,000. Residence nil-rate band (RNRB): £175,000 (assuming property left to direct descendants and estate under £2m). Total available threshold: £500,000. Taxable estate: £300,000. IHT at 40%: £120,000.

Scenario B: No surviving spouse, RNRB not available (estate left to siblings)

Standard nil-rate band only: £325,000. Taxable estate: £475,000. IHT at 40%: £190,000.

Before April 2027, in both scenarios, the pension pot of £350,000 would have been excluded entirely, reducing the taxable estate to £450,000 in Scenario A (with a £0 IHT liability) and £450,000 in Scenario B (with a £50,000 liability). The difference is stark.

Nil-Rate Bands: A Reminder

The standard nil-rate band (NRB) is £325,000. It has been frozen at this level since 2009 and the freeze is confirmed to continue until at least 2030. This means that inflation is steadily pulling more estates into the IHT net.

The residence nil-rate band (RNRB) adds up to £175,000 on top of the standard NRB, but it comes with conditions. You must leave a main residence (or the proceeds of one, if it has been sold) to direct descendants — children, grandchildren, stepchildren and so on. The full RNRB is only available where the total estate is valued below £2 million; above that, it tapers away at £1 for every £2 of excess until it is eliminated at £2.35 million.

Both the NRB and the RNRB are transferable between spouses and civil partners. On the second death, the unused allowances from the first death can be claimed, potentially providing a combined threshold of up to £1 million.

The Spousal Exemption and Second Death Risk

Transfers between spouses and civil partners are completely exempt from IHT. This means that on the first death, any assets — including pension funds from April 2027 — passing to a surviving spouse or civil partner do so free of IHT regardless of value.

The problem, therefore, is not the first death but the second. Once the surviving spouse dies, the pension pot — which they may have inherited or which they hold in their own right — becomes part of their estate along with all other assets. If the combined estate on second death is substantial, the IHT liability can be very large. Planning must therefore account for the second-death scenario rather than simply the immediate position.

Planning Action 1: Drawdown Strategy

One of the most significant shifts for pension holders post-2027 is the logic of drawdown sequencing. Previously, the optimal strategy for IHT-planning purposes was often to spend non-pension assets first and leave the pension untouched, since the pension would eventually pass tax-free. From April 2027, that logic reverses or at least becomes much more nuanced.

If the pension is going to face a 40% charge on death anyway, spending the pension first — and leaving other assets that benefit from the uplift in capital gains tax base cost on death — may be more efficient overall. Pension income is taxable (above the tax-free cash entitlement), but the marginal income tax rate paid in retirement may well be lower than 40%. Drawing the pension down in a measured way to stay within the basic rate or not exceed a comfortable income tax band, while passing on ISAs or property that benefit from other allowances, is a strategy worth modelling carefully with an adviser.

Planning Action 2: Review Your Nomination Forms

Nomination of beneficiary forms tell the pension scheme trustees who you would like to receive the death benefits. Even with the IHT change, the form in which benefits are paid — as a lump sum, as a drawdown account, or as an annuity — can affect the tax position. Lump sum death benefits paid to a discretionary trust may be treated differently from direct payment to individuals in some circumstances.

Review all nomination forms now. Check they name the people you actually want to benefit and that contact details are current. Consider whether a trust nomination for the lump sum death benefit element may suit your circumstances. Pension trustees are not legally bound by nomination forms, but they will take them as a strong indication of your wishes.

Planning Action 3: Whole-of-Life Insurance Written in Trust

A whole-of-life insurance policy written in an appropriate trust sits outside your estate and can provide a lump sum to beneficiaries specifically to cover an IHT liability. Because the policy is held in trust, the proceeds are paid directly to the trustees (who are typically your beneficiaries) and do not pass through your estate.

The cost of a whole-of-life policy depends on your age, health and the amount of cover required. For older individuals or those in poor health, the premiums may be prohibitive. However, for those in their 50s with a significant potential IHT liability, taking out a policy now — while premiums are relatively affordable — is worth serious consideration. The cost of the premiums may be far less than the IHT liability the policy would cover.

Planning Action 4: Regular Gifts From Income

If you are drawing pension income that exceeds your living costs, regular gifts from the surplus may qualify for exemption from IHT under the normal expenditure out of income exemption. This exemption is available where gifts are made habitually, form part of your regular expenditure, and do not reduce your standard of living. There is no monetary cap on the exemption provided these conditions are met.

This is one of the most underused IHT exemptions. Documenting the gifts carefully — maintaining records that show the pattern of income, expenditure and gifts — is essential to support a claim by your executors at the time of death.

Planning Action 5: Revisiting Pension Contribution Strategy

Prior to the October 2024 Budget announcement, one argument in favour of maximising pension contributions was their IHT-exempt status. For higher earners who had already used up other allowances, topping up a pension was a tax-efficient way to pass wealth to the next generation.

From April 2027, that argument disappears. Pension contributions still attract income tax relief and the funds grow free of tax within the wrapper, so they remain attractive on those grounds. But the additional IHT advantage that previously existed will no longer apply. Anyone currently making large pension contributions primarily or partly for estate planning reasons should review whether that remains the optimal approach, given the other options available.

What Is Not Changing

It is important to be clear about what the April 2027 change does not affect. The Lump Sum Allowance — the amount you can take as tax-free cash from a pension over a lifetime, currently £268,275 — is entirely separate from IHT. The IHT change does not alter your entitlement to tax-free cash during your lifetime.

The income tax rules on inherited drawdown funds also remain in place. If you die before the age of 75, a beneficiary who inherits your defined contribution pension drawdown fund can draw from it free of income tax. If you die at 75 or over, the beneficiary pays income tax at their marginal rate on withdrawals. These rules sit alongside the new IHT charge — both may apply to the same funds.

Acting Now

The April 2027 date gives those affected roughly a year to take preparatory action. Many financial advisers are already seeing increased demand for estate planning reviews. The combination of frozen nil-rate bands, rising property values and the new pension inclusion will push a significant number of estates into IHT territory for the first time.

If your estate — including pension funds — is likely to exceed £325,000 (or £500,000 where the RNRB applies), it is worth arranging an independent financial advice review before the end of 2026. The planning options outlined above are most effective when put in place with time to mature — insurance policies, drawdown strategies and gifting programmes all work better the earlier they are started.