Pensions and Inheritance Tax from 2027: Planning Guide

The announcement that unspent pension pots will be brought into inheritance tax from April 2027 upends one of the most powerful estate planning tools available to UK retirees. For the past decade, many wealthy retirees deliberately preserved their defined contribution pension -- choosing to spend ISA savings, property proceeds, and other investments first -- because the pension passed outside their estate free of IHT. From 2027, that advantage disappears.

How the Current Rules Work -- and Why They Are Being Changed

Under the current rules (applying until April 2027), unspent defined contribution pension funds fall outside a deceased person's estate for IHT purposes. If you die before age 75 with money in your pension, your nominated beneficiaries can receive it free of income tax as well as outside IHT. If you die at 75 or over, the pension passes to beneficiaries who pay income tax at their marginal rate, but still no IHT.

This made pensions the ultimate estate planning vehicle for wealthier individuals. A retiree with a £500,000 pension and £500,000 in ISAs would, in many cases, choose to draw from the ISA first and leave the pension intact, because:

• Pension remains outside estate (no 40% IHT)
• Pension grows tax-free inside the pot
• On death the pension could be passed to children or grandchildren, who continue to draw it down as income

The government's view is that this creates a significant and unintended incentive to treat pensions as inheritance vehicles rather than retirement income vehicles. The reform brings DC pensions back into the IHT net, restoring the original purpose of the pension as a savings vehicle for retirement rather than for wealth transfer.

How the New Rules Will Work from April 2027

From April 2027, the unspent value of a DC pension fund will be treated as part of the deceased's estate for IHT purposes. The pension scheme trustees and HMRC will share responsibility for calculating and collecting the IHT due on pension assets.

Under the proposed administrative approach:

• HMRC informs the pension scheme of the IHT due on the pension assets
• The pension scheme pays the IHT from the pension fund before distributing the balance to beneficiaries
• The pension scheme then deducts the IHT paid from the amount available for beneficiaries

The coordination between the scheme and HMRC is new and administratively complex. Pension providers will need to know the total estate IHT position (including non-pension assets) to calculate the correct proportion of IHT attributable to the pension pot, since IHT nil-rate bands and other reliefs are applied across the whole estate.

Defined Benefit Pensions: Different Treatment

Defined benefit (final salary) pensions are not primarily affected by the IHT change in the same way as DC pots, because they typically do not leave a pot of money to beneficiaries. On the death of a DB scheme member, the scheme usually pays:

• A dependant's pension (a fraction of the member's pension) continuing for the life of the surviving spouse or civil partner
• A lump sum death in service benefit for members who die before retirement (which may be covered by a separate life assurance trust and sit outside the estate)

A continuing income (spouse's pension) is not a capital sum in the estate, so it is not subject to IHT under either current or proposed rules. However, some DB schemes also have a lump sum commutation option or a return-of-contributions option at death -- these may be caught by the new rules if they result in a payment of capital that would otherwise have been in the pension fund.

The position for DC members who have partially or fully converted their pot to a guaranteed annuity is also different (see below).

Annuitisation as a Planning Tool

A guaranteed annuity converts a DC pot into a fixed income stream that ceases (or is reduced) on death. Once you purchase an annuity:

• There is no residual pension pot to pass to beneficiaries
• The annuity income was in exchange for the capital, so no capital is in the estate

From an IHT perspective, buying an annuity with your pension pot removes it from the IHT charge -- there is nothing left in the pension fund to include in the estate. The trade-off is that you give up control of the capital: if you die early, the capital is lost (subject to any guarantee period).

Annuity rates in 2026 are more attractive than they were a decade ago because of higher long-term interest rates. For individuals in good health who do not wish to leave a large inheritance, an annuity may become more attractive once the pension IHT change removes the incentive to retain a pension pot. For those in poor health, annuity rates may be prohibitive.

Gifting from Pension Income

Once you are drawing pension income in retirement, that income is yours to spend or give away. Gifts made from regular income are exempt from IHT under the "normal expenditure out of income" exemption, provided:

• The gifts are regular (habitual, not one-off)
• They are made from income (not capital)
• You are left with sufficient income to maintain your usual standard of living

If you are drawing a pension and wish to reduce your estate, making regular gifts to children or grandchildren from that income is a powerful IHT tool. You could gift:

• Regular monthly payments to children
• Premium payments on a life assurance policy written in trust for your heirs
• Contributions to children's Junior ISAs (up to £9,000 per year)

These gifts immediately reduce your estate with no 7-year survival requirement, because they qualify as normal expenditure from income.

Reviewing Nomination of Beneficiaries

DC pension death nominations (expression of wishes) tell the pension trustees who you wish to receive your pension. Currently, these nominations are made on the basis that pensions sit outside IHT. After April 2027, the identity of beneficiaries affects whether IHT advantages apply:

• Spouse or civil partner beneficiaries: transfers between spouses are IHT-exempt (unlimited spouse exemption). A pension nominated entirely to a spouse could be entirely IHT-exempt on first death, with IHT only arising on the survivor's death.
• Charity beneficiaries: gifts to UK registered charities are IHT-exempt. Nominating a charity as pension beneficiary removes those assets from IHT.
• Other beneficiaries: children, grandchildren, and other individuals do not benefit from the spouse exemption, so their inheritance from the pension may be subject to IHT.

Reviewing and potentially updating your expression of wishes to maximise spouse exemption and charitable exemption is a straightforward but potentially very valuable step.

Interaction with the Death Tax on Post-75 Pensions

Currently, DC pensions paid from the pot of a member who died at age 75 or over are taxed as income in the hands of the beneficiary at their marginal rate. This income tax charge is separate from the IHT reform but both will apply from April 2027.

HMRC is consulting on how the two charges interact to avoid double taxation where the full value is exposed to both IHT (at 40%) and then income tax in the beneficiary's hands. The expectation is that the IHT charge reduces the amount available, and income tax applies to what remains -- but the technical mechanics of relief are still being finalised. Watch for updates in the Finance Bill 2026.

The April 2027 pension IHT reform is a significant change requiring proactive review of estate planning strategies built around DC pensions. Whether through drawdown sequencing, annuitisation, income gifting, or beneficiary nomination changes, there are real actions to take before the change comes into force.