Tax treatment depends on your circumstances and is subject to change
Pensions aren’t just about funding retirement; they’ve also been one of the most effective ways to pass on wealth tax-efficiently to the next generation.
At present, pensions usually sit outside your estate for inheritance tax (IHT) purposes. But from April 2027, the government is changing the rules.
If you are 50 or over and starting to think seriously about retirement and your legacy, it’s important to understand what’s happening, why, and how planning ahead could make a real difference.
When reading this article, please bear in mind that tax treatment depends on your circumstances and is subject to change.
Right now, pensions normally fall outside of your estate for IHT purposes. That means that when you die, your pension savings can often be passed on to beneficiaries without being subject to inheritance tax. This treatment has made pensions an important tool for estate planning as well as retirement income.
For example, if you pass away with £500,000 in a pension pot and £400,000 in other assets, the £500,000 would generally sit outside your estate. Only the £400,000 would be tested against your IHT nil-rate band (currently £325,000, plus the residence nil-rate band of £175,000 where applicable). This has given pensions a unique advantage compared with other savings and investment accounts.
Alongside this, the inheritance tax nil-rate band, the amount you can pass on before tax is due, is currently frozen at £325,000 until at least April 2028. The residence nil-rate band of £175,000 is also frozen.
These freezes mean that more families are being brought into IHT each year as asset values rise. Historically, fewer than 5% of estates have paid IHT1, but with allowances static and house prices and pensions growing, this percentage is expected to increase steadily.
From April 2027, pensions will no longer automatically fall outside of your estate for inheritance tax. Unused pension funds left on death will, in most cases, be treated as part of your estate for IHT purposes. This change applies to funds left unused at death, rather than pensions already crystallised into annuities or drawn down in payment That means they could be subject to 40% tax if the value of your estate is above the nil-rate bands.
This is a significant shift. For many years, pensions have been seen not just as retirement vehicles but also as highly effective estate planning tools. The government’s stated rationale is to ensure fairness and consistency in the tax system, particularly given the growth in pension savings since auto enrolment and pension freedoms were introduced.
In practice, this means that families who might not previously have faced an IHT bill could now find themselves doing so. Those with larger pension pots, or combined family wealth that exceeds the frozen allowances, will need to be particularly aware.
For those in their 50s and beyond, this change could have a big impact on how pensions are used in estate planning. If pensions are brought within IHT, relying on them as a way of passing wealth to children or grandchildren may no longer be as efficient. Instead, decisions about when to draw income, how to structure retirement savings, and how to balance pensions with ISAs and other assets will become more important. It’s also worth remembering that while higher-rate taxpayers enjoy more generous relief on contributions, they may ultimately face greater IHT exposure when passing on their wealth.
While pensions are often the largest single asset many people hold after their home, they are just one piece of the estate planning puzzle. With allowances frozen and asset values rising, proactive planning becomes even more essential.
Consider Jane, age 55, with a pension worth £600,000 and other assets of £300,000. Under current rules, only the £300,000 would be tested against IHT allowances, keeping her estate largely free of inheritance tax. From April 2027, the full £900,000 would be included. After allowances of £500,000 (assuming both the nil-rate and residence nil-rate bands apply), £400,000 could be subject to IHT at 40%. That’s £160,000 in potential tax – a dramatic shift from the current position. With advice, Jane might decide to start drawing from her pension earlier or restructure her assets to reduce this potential liability.
Or take David, age 65, with a smaller pension of £200,000 and assets of £250,000. Today, his estate would likely fall under IHT thresholds. But by 2027, if his home or investments grow in value, he may find himself above the frozen allowance. Even families who never considered themselves ‘wealthy’ could face a tax bill.
While the changes may sound worrying, the good news is that there are steps you can take:
You might decide to draw on your pension earlier in retirement rather than leaving it untouched, reducing the size of your pension pot at death. Or you may explore other estate planning strategies, such as gifting, using ISAs (which have different inheritance tax treatment), or making use of trusts. Ensuring that your pension nominations are up to date is also vital, as this determines who will inherit your benefits.
The key point is that there is no one-size-fits-all answer. What works for one family may not work for another. That’s why taking professional advice is so important. A qualified adviser can model different scenarios, weigh up the pros and cons, and guide you through the most suitable strategy for your personal circumstances.
It’s also worth setting these pension changes in the wider context of inheritance tax policy. Freezing allowances while asset values rise effectively means more families being drawn into the scope of IHT. According to HMRC data, fewer than 5% of estates currently pay inheritance tax, but this percentage is likely to rise year by year. Combined with the new treatment of pensions from 2027, many families who never expected to face IHT may need to reconsider their plans.
This does not mean panic is required. What it does mean is that sensible, early planning can help you manage the situation. By reviewing your finances in advance, you can take steps to protect your retirement lifestyle while still thinking carefully about the legacy you leave.
Pensions have long been seen as one of the most effective ways to pass on wealth outside of inheritance tax. From April 2027, that position changes. With nil-rate bands frozen and more estates being drawn into IHT, the value of tailored planning becomes even greater. By acting early, you can make informed choices about how best to use your pensions and other assets.
If you are in your 50s or approaching retirement, now is the time to review your plans with a qualified adviser. Taking action now will help you navigate the changes with confidence and avoid being caught out. Good planning can ensure that your financial future, and the legacy you want to leave, have the best chance to remain secure.
We can help you to make the best possible decisions when it comes to your pension.
Taking pension money early is not right for everyone as it will leave you worse off in retirement. Also, tax treatment depends on your circumstances and is subject to change. That’s why it makes sense to get help from a regulated specialist.
