Pensions and Inheritance Tax: Big Changes Coming in 2027

From 6 April 2027, the way pensions are treated for inheritance tax (IHT) will change significantly. Currently, unused pension pots can often be passed on free of IHT. This makes pensions an effective estate planning tool.

But what exactly is an “unused pension pot”?

In simple terms, this refers to pension savings that remain in your pension scheme at the time of your death. These are funds that you have not yet withdrawn or used for retirement income.

This could include:

• A workplace pension
• A private pension (personal pension or SIPP)
• Certain overseas pension schemes

These funds remain within a pension wrapper, managed by a pension provider. They are not held in a standard bank account.

It is important to understand that:

• Money in a normal savings account is not a pension
• ISAs, including Lifetime ISAs (LISAs), are not treated as pensions for IHT purposes
• Only funds held within a recognised pension scheme qualify as a “pension pot”

This distinction is key, as pensions have historically benefited from different tax treatment compared to other assets.

According to industry estimates, billions of pounds remain in unused pension savings across the UK. Many individuals deliberately preserve their pension and instead draw on other assets in retirement. This strategy has been widely used to pass wealth to the next generation in a tax-efficient way.

However, under the new rules, most unused pension funds and death benefits will be included in your estate for IHT.

This could significantly increase the tax your family pays.

What Is Changing in 2027?

The government is reforming how pensions are treated on death.

From April 2027:

• Unused pension pots will form part of your estate for IHT
• The current IHT exemption for many pension death benefits will be removed
• Personal representatives will be responsible for reporting and paying IHT
• Pension scheme administrators will need to provide detailed information

These changes apply to most registered pension schemes and certain overseas pensions.

Some benefits will remain exempt, including:

• Transfers to spouses or civil partners
• Death-in-service benefits
• Dependants’ scheme pensions

What This Means for You

These changes could have a significant impact on your estate.

You may find that:

• Your estate becomes liable for more inheritance tax
• Your beneficiaries receive less than expected
• Pension planning is no longer separate from estate planning

Many people have relied on pensions as a tax-efficient way to pass on wealth. This may no longer be the case.

Will Your Pension Pot Be Subject to IHT?

It is important to understand that not every pension pot will automatically trigger an IHT bill. Your pension pot is not taxed in isolation — from 2027 it will simply be added to the rest of your estate, and the total is then measured against your available IHT thresholds.

Everyone has a nil-rate band (NRB) of £325,000. Below this threshold, no IHT is due at all. There is also an additional allowance called the residence nil-rate band (RNRB) of up to £175,000, which applies when you leave your main home to direct descendants such as children or grandchildren.

This means:

• A single person could potentially pass on up to £500,000 free of IHT
• A married couple or civil partners can combine their allowances to pass on up to £1,000,000 tax-free

What matters is the size of your total estate once the pension is included. So:

• A small pension pot in an otherwise modest estate may trigger little or no IHT
• A small pension pot added to an already large estate could still push the total further into IHT territory
• A large pension pot, even if it is your primary asset, may still fall within your available thresholds depending on your overall circumstances

There is no minimum pension pot size below which IHT is automatically exempt. Every situation needs to be looked at in the round.

It is also worth noting that the spouse and civil partner exemption remains intact. If you leave your pension and other assets to a spouse or civil partner, no IHT is due regardless of the size of the pot. The IHT question becomes most relevant when assets pass to the next generation — children, grandchildren and other beneficiaries.

A Practical Example

Consider this scenario, using a £100,000 unused pension pot:

In this example, the total tax burden is £64,000 out of a £100,000 pot – meaning the beneficiary receives just £36,000.

Understanding the Tax Impact

The interaction between inheritance tax and income tax is important – but it is worth understanding how the two taxes interact following a recent change to the legislation.

The Finance Bill includes a clause specifically designed to prevent the same money being taxed twice. In simple terms, IHT and income tax will not both be charged on the same portion of the pension fund.

Here is how it works in practice:

• IHT is calculated and paid on the pension pot first
• The portion used to pay IHT is then excluded from income tax
• Only the remaining balance – after IHT has been deducted – is subject to income tax at the beneficiary’s marginal rate

So in our example above, income tax applies only to the £60,000 left after IHT, not the full £100,000. This is an important protection, but it does not eliminate the income tax liability on the remainder.

It is worth noting that this legislation is still relatively new and has been described as complex, even by tax experts. The key confirmed position from the Treasury is that while the same money will not face both taxes, any remaining pension death benefits will still be subject to income tax at the beneficiary’s marginal rate as normal.

However, there are still reliefs available:

• Transfers to spouses and civil partners are usually exempt from IHT
• Gifts to charities remain exempt from IHT

New Responsibilities for Personal Representatives

The changes will also affect how estates are administered.

Personal representatives (the people dealing with your estate) will need to:

• Work with pension providers to obtain valuations
• Report pension assets to HMRC
• Ensure IHT is paid correctly

In some cases, they may ask pension providers to withhold part of the funds to cover tax.

This adds a new layer of complexity to estate administration.

Steps to Take Before 2027

There is still time to plan.

You should consider:

• Reviewing your pension nominations
• Checking who your beneficiaries are
• Considering whether to draw down pension funds earlier
• Reviewing your will and overall estate plan
• Exploring trust options where appropriate
• Taking professional advice

Early planning can help reduce your tax exposure and protect your family.

How mlplaw Can Help

At mlplaw, we help clients prepare for changes like these with clear and practical advice.

Our Wills, Trusts and Probate team can:

• Review your pension and estate planning strategy
• Advise on tax-efficient ways to pass on wealth
• Update your will to reflect the new rules
• Help you balance income needs with long-term planning

We take the time to understand your situation and guide you through complex changes.

Conclusion

The 2027 pension changes represent a major shift in estate planning. Pensions may no longer offer the same inheritance tax advantages. Without planning, your estate could face a higher tax bill. By taking advice now, you can put the right structures in place and protect your family’s future.