The latest changes to pensions and inheritance tax

With further updates on the horizon, our wills, trusts & probate experts highlight the latest changes to pensions and inheritance tax, and what they mean for you.

Since the announcement at the Autumn Budget in 2024, pensions have been a frequent talking point for clients when reviewing their wills and estate planning. Previously, it was the position that pensions did not form part of a deceased’s estate for inheritance tax (IHT) purposes – now, the latest changes to pensions and inheritance tax mean that is all set to change.

From 6 April 2027, the government plans to include most unused pension funds and death benefits when calculating the value of a deceased estate. This will include funds paid out as a lump sum, an annuity or funds drawn down. This will have a significant impact on many people, particularly those whose estates are valued at around the £2m level where the availability of the residence nil rate band allowance begins to taper before becoming completely unavailable.

In addition, the nil rate band allowance – the amount everyone can usually pass on free of IHT (subject to gifts made and trusts set up within seven years before death) – has also been frozen at its current level of £325,000 for an additional two years, now until 2030. Therefore, many people whose estates were not liable to IHT may well become so.

There is also the potential of ‘double taxation’ to consider. The pension pot could be liable to IHT on death and income tax then being payable on any pension withdrawals (where death is after age 75). The effective rate of tax has the potential to be as high as 67%.

Pensions have long been thought of as an ideal way to save funds due to the favourable income tax and IHT treatment together with the tax-free growth on funds.

Pensions are usually passed at the discretion of the pension provider trustees directly to beneficiaries with the aid of a nomination form (or letter of wishes) completed in the deceased’s lifetime. The new rules mean that, from 6 April 2027, most pensions (those known as defined contribution pensions) will become taxable as IHT will be payable on the gross value of the pension funds immediately before death. Defined contribution pensions are those that build a regular pot of funds through contributions and investment growth. These are most often the schemes offered by employers to employees.

What are the reasons for changes to pensions and inheritance tax?

Despite the IHT changes, pensions do remain a tax efficient way to save funds, but from 2027, the significant IHT advantages will be lost. The government has said that the reasoning behind the changes is to encourage spending of pensions in retirement rather than leaving them untouched to pass on as an inheritance free of tax.

There are some exceptions to pensions being included in the proposed new rules, such as defined benefit pensions (known as final salary pensions) and some lump sums that are being paid to charities.

One exemption that will also continue to apply is the ‘spouse exemption’, so any assets being left to a surviving spouse or civil partner will continue to be free of IHT on the first death.

With the changes not due to take place for another two years, it is advisable to ensure that all pension scheme nominations are up to date and to take advice from a financial advisor. Those reviewing their wills and estate planning should also ensure that wills are up to date and provide for the people they wish to benefit.

You can contact our wills, trusts & probate team for more information and advice about your individual circumstances and how you may be affected.

Our Legal 500-rated wills, trusts & probate team has the expertise to help you plan for the future and guide you through any difficult challenges that may arise, including those relating to pensions and inheritance.