Pensions and Inheritance Tax: What’s Changing in 2027 and How It Could Affect You

From 6 April 2027, a significant change in UK inheritance tax (IHT) law will come into effect. Most unused pension funds and death benefits will be brought into the scope of inheritance tax.

This is a notable shift. For years, defined contribution pensions, where you build up a pot of money for retirement, have generally been excluded from IHT. Under the upcoming rules, they will be counted as part of your estate when you die and could be taxed at the standard 40 percent rate above the available tax-free thresholds.

While legislation has not yet been finalised and further details are expected, the broad direction is clear. The change will have particular implications for families with larger combined assets.

How Inheritance Tax on Pensions Works Now

At present, most defined contribution pensions are not part of your taxable estate for IHT purposes. This means you could pass on unused pension funds to your beneficiaries without triggering a tax bill. This is a significant planning advantage, especially for those with other high-value assets.

What Will Change in 2027

From April 2027:

  • ⁠  ⁠Most unused pension funds will be included in your taxable estate.
  • ⁠  ⁠The responsibility for reporting and paying IHT on pension death benefits will shift from pension scheme administrators to the Personal Representatives (PRs) of the deceased’s estate.
  • ⁠  ⁠Death-in-service benefits from registered pension schemes will remain exempt from IHT.
  • ⁠  ⁠New information-sharing processes between pension providers, PRs and HMRC will be introduced, alongside a planned digital IHT service.

Government estimates suggest:

  • ⁠  ⁠10,500 estates will pay IHT for the first time.
  • ⁠  ⁠38,500 estates will pay more IHT than they would under the current rules.

Who Will Be Affected

Most estates will still fall under the IHT threshold. Everyone has a £325,000 nil rate band, the amount you can pass on tax-free. Married couples or civil partners can combine theirs, giving a potential £650,000 allowance.

There is also the Residence Nil Rate Band (RNRB), which allows up to an extra £175,000 each to be passed on tax-free if you leave a property to direct descendants. Combined, this means a couple could pass on up to £1 million before IHT applies, assuming all conditions are met.

However, for individuals and couples with valuable pensions, property and other investments, these allowances can be exceeded quickly. The inclusion of pensions in IHT calculations will push more estates over the threshold.

Married vs Unmarried Couples

Married couples or civil partners: Can transfer unused allowances to each other and pass assets tax-free on the first death.

Unmarried couples: Cannot transfer allowances or pass assets free of IHT on death, which can mean higher potential tax bills.

Planning Ahead

While these changes will not affect everyone, they highlight the importance of proactive estate planning, particularly for those with significant pension savings.

Steps to consider:

  • ⁠  ⁠Review your estate’s projected value with pensions included.
  • ⁠  ⁠Assess whether you could make lifetime gifts to reduce your taxable estate, such as helping children or grandchildren with property deposits or pension contributions.
  • ⁠  ⁠Speak to a financial adviser about tax-efficient drawdown strategies in retirement.
  • ⁠  ⁠Keep your will and pension beneficiary nominations up to date.

Final Thoughts

The inclusion of pensions in IHT from 2027 marks a fundamental change to the way estates are valued. For some, it will have no impact. For others, it could mean substantial new tax liabilities.

At Arlingsworth Solicitors, our private client team works closely with financial advisers to help you prepare for legislative changes and protect your family’s future.

If you would like tailored advice on how these changes could affect you and what steps you can take now, contact us today