When you think retirement, most will also think Pensions. For many, the attractiveness lies in its tax benefits both in the case of a drawdown and when the remaining funds are passed on to beneficiaries. However, from April 2027, Pensions will no longer be exempt from Inheritance Tax (IHT) which is a massive hit to the appeal of Pensions for many.
What's Changing?
Currently, if you die before age 75, your unused pension pot (whether you have begun drawing down or not) can be passed on to beneficiaries completely free of income tax and IHT.
If you die after age 75, your beneficiaries pay income tax on withdrawals but still, no IHT.
From April 2027, any unused pension pot will be treated as part of your taxable estate no matter the age of death. An ‘estate’ simply means all the assets someone owns when they die e.g. house, investments or valuables. Pensions were previously exempt from the estate and therefore non-taxable but with these changes, it means your unused pension will be added to the value of your estate when calculating the 40% IHT.
What's the impact?
Well, it won't impact everyone. This is due to the IHT threshold which permits any one person to have a total valued estate of £325,000 free from IHT.
For those whose estate value is close / above the threshold, this could significantly increase the tax bill your beneficiaries pay. For example:
❍ An estate value of £400,000: IHT is due on £75,000 only as the value above £325k. This amounts to £30,000 (£75,000 x 40%)
❍ Now adding a Pension pot of £200,000 to the total estate value, bringing it to £600,000: IHT is due on £275,000. This amounts to £110,000 of IHT
That's an additional £80k in tax for your beneficiaries due to unused Pensions now included in taxable estate value.
So, what can you do about it?
There will be varying options to exercise depending on one's circumstances. It's best to speak to a Financial Adviser for appropriate guidance. Here are some common tactics to note:
- Consider a Trust - moving assets into Trust while alive could reduce your estate value. Trusts have their own tax rules and limits so research and necessary calculations will still be required
- Spend pension funds before other assets - Typically, individuals will draw on Pensions last but as they will lose their IHT advantage, it may make sense to draw from here earlier in retirement
- Life insurance cover - specific covers will permit the IHT bill to be covered by the policy. Speak to a broker to discuss options
To note, there are some rules surrounding marriage and civil partnership, how you distribute your estate and other factors which alleviate the impact of these changes.
So, yet another tax change to keep up with.
✉️ This newsletter was originally sent to subscribers on 13th August 2025. Want to get future newsletters straight to your inbox? Subscribe here.