Since 2015, pensions have generally been exempted from Inheritance Tax (IHT), making them one of the most tax-efficient ways to pass on wealth.
However, from April 2027, this is set to change.
Although the details are not yet finalised, the proposed reforms will make pensions liable for IHT, potentially increasing tax bills for thousands of estates.
Indeed, the government estimates that around 10,500 new estates will face IHT as a result, while 38,500 estates could see higher bills than under the current system. With almost 50,000 estates affected, now is a good time to review your estate plan and ensure you’re prepared.
Read on to find out more about the reforms and what you can do to prepare for them.
How pensions are treated under current rules
The current rules were introduced with Pension Freedoms in 2015. They allow people more flexibility in accessing their pensions and affect how pensions are taxed on death.
- Defined Contribution (DC) pensions are generally outside your estate for IHT purposes.
- Defined Benefit (DB) pensions are usually exempt too, though the treatment can vary by scheme.
Even if your pension is free from IHT, your beneficiaries may still be liable for Income Tax, depending on your age at death.
Pensions could be liable for Inheritance Tax from 2027
In last year’s Autumn Budget, the government announced that the current rules regarding pensions and IHT are set to change in 2027.
This means your pension could be considered part of your estate and be liable for IHT if it exceeds your nil-rate band.
As your pension is likely one of the largest assets you hold, this change could mean a significant portion of it becomes liable for IHT.
Responsibility for reporting and paying any pension-related IHT will likely fall on the representatives of your estate, though pension administrators will still support the process. However, these details have yet to be finalised.
4 steps that can help protect your pension from Inheritance Tax
With the proposed rules set to come into effect in 2027, here are four steps that can help protect your pension from IHT.
1. Maximise nil-rate bands
Nil-rate bands are the thresholds above which IHT is charged.
In the 2025/26 tax year, the main allowances are:
- £325,000 for the standard nil-rate band – Assets in your estate valued above this threshold may be liable for 40% IHT.
- £175,000 for the residence nil-rate band – This allows you to pass on an additional portion of wealth through your main residence, provided it is left to direct descendants. When combined with the standard nil-rate band, up to £500,000 can be passed on free from IHT. However, the residence nil-rate band tapers on estates worth over £2 million, reducing by £1 for every £2 over the threshold.
- Spousal allowances – If you’re married or in a civil partnership, you can combine unused allowances. This means you can potentially pass on up to £1 million collectively before IHT applies.
Making full use of these allowances is one of the most effective ways to reduce your potential IHT liability. So, it’s a good idea to revisit your estate plan to ensure you are fully prepared.
2. Draw down more from your pension
Reducing the size of your pension during your lifetime is one of the simplest ways to ensure less of it is liable for IHT when you die.
Indeed, this is proving to be a popular strategy. Simply Business reports that 56% of retirees plan to use more of their pension while they’re alive in light of the proposed reforms.
While you might want to use your savings for your own goals, you can also use your withdrawals to support your loved ones, ensuring they receive more benefits from the retirement fund you’ve built up over decades.
You could, for example, contribute to a child’s pension or Junior ISA, or make gifts, though remember that this money may still be subject to IHT if you pass away within seven years.
If you choose to spend more of your pension while you’re alive, it’s important to create a withdrawal strategy. That way, you can ensure your savings remain sufficient for your retirement goals while also reducing the amount liable to IHT.
3. Explore Business Relief schemes
Investing in certain Business Relief (BR) assets can also help reduce your IHT liability significantly.
Usually, you must have owned the assets for at least two years before death, but if you have done so, they could be eligible for either 50% or 100% relief, depending on the asset.
Because BR investments can carry higher risk and have complex rules, it’s a good idea to speak to a financial planner before exploring this strategy.
4. Take out life insurance and put it in trust
Life insurance can pay out to your beneficiaries upon your death. If you put it in trust, it is typically considered outside your estate for IHT purposes.
So, by using your pension savings to pay for a life insurance policy in trust, you can effectively take some of your pension outside of your estate, and your beneficiaries will receive it IHT-free when you die. They can then use the proceeds to help settle any remaining IHT liability.
This is a complex strategy that can be effective if done correctly. A financial planner can advise on whether it fits your circumstances and how to structure it efficiently.
It’s a good idea to start planning for the reforms now
With the reforms set for 2027, it’s important to start preparing now to ensure more of your wealth is passed on according to your wishes.
A financial planner can help you:
- Maximise your available IHT allowances
- Structure your pension withdrawals efficiently
- Explore Business Relief and insurance strategies
- Protect your long-term financial security.
Our team of independent financial advisers in Lewes is here to support you and ensure more of your pension is left to your loved ones.
To find out more, please get in touch by emailing us at financial@barwells-wealth.co.uk or by phone on 01273 086 311.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or will writing.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Note that life insurance and financial protection plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
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