In April 2027, a big change is set for pensions. At that point, unused pension funds will fall under an individual’s estate when they die. In short, this could leave them subject to inheritance tax (IHT), whereas previously defined contribution (DC) pensions were exempt.
This change has significant implications - not just for retirement planning, but also for estate planning. Below, our team of financial planners at Castlegate discuss the implications of the change, why it has come about, and how taxpayers can prepare.
The change was announced last year in the Chancellor’s 2024 Autumn Statement. She set her case that the UK economy was facing a £22bn “black hole”, requiring urgent tax rises.
Several steps were taken, including an immediate increase in capital gains tax (CGT). Pensions would also lose their IHT exemption, following the recommendation of a public consultation. The change would arrive in April 2027, giving taxpayers nearly three years to make arrangements.
In 2025-26, the standard rate of IHT is 40% on the value of an estate if it is valued over £325,000 when the owner dies. For instance, if you die owning £500,000 in assets which do not qualify for any exemptions, then your IHT bill is likely to be £70,000.
Many people with pensions are now understandably concerned, with many containing hundreds of thousands of pounds. Previously, these assets were largely safe from IHT, with any unused funds going to their loved ones. From April 2027, this may no longer be certain.
The UK is quite unique on the world stage in that IHT is paid out of the original owner’s estate. In other countries, it is common to levy inheritance or gift tax on the person receiving the asset.
So, technically, people in the UK receiving an inheritance will not pay IHT to the UK government. This is handled by the executors (or administrators) of the deceased person’s estate. However, if they die after April 2027, beneficiaries may receive less from unused pension funds if these are eroded by the new IHT regime.
Even now, beneficiaries may need to pay extra income tax on inherited pension funds if the original owner dies after their 75th birthday. Intergenerational financial planning can be particularly helpful for families facing complex tax issues like these.
Before the Labour Government announced the change to pensions and IHT, it was common for pensioners to focus their withdrawals from non-pension accounts early in their retirement (e.g. ISAs), which did not qualify for IHT exemption.
However, with this change looming, is it still worthwhile preserving your pension? After all, using up your pension could lower your future IHT liability if it sits above the nil rate band (NRB - i.e. the £325,000 tax-free threshold for IHT). The answer is not universal, nor is it straightforward.
For instance, making higher withdrawals now could push some individuals into a higher income tax bracket. There is also the matter of longevity. Might you need extra funds later in life (e.g. to help fund your care)? You also want to avoid threatening your pension’s sustainability. It would be tragic to run out of money in retirement purely out of a desire to avoid IHT!
Tailored financial advice can help you navigate the issues here in light of your specific goals and unique circumstances.
Historically, DC pensions have had a key advantage over annuities - you can pass down unused funds from the former to your loved ones as an inheritance. The latter, by contrast, typically did not continue to pay out to beneficiaries when the owner died - although many schemes would pay out a lower rate to specific dependents, such as a surviving spouse.
With the IHT exemption on DC pensions falling away, annuities have arguably become more attractive for many people. Not only can they offer a high degree of income stability (since the provider shoulders the investment burden), but they can also help reduce a future IHT burden.
Again, the suitability of an annuity varies on a case-by-case basis. Annuities can also be subject to IHT (e.g. guarantee periods and valuation protection payments), so it’s worth seeking advice so you can consider the options with the best available information and professional guidance.
The upcoming change to pensions and IHT is one of the biggest changes to the tax system in recent years. Many families will be impacted.
Fortunately, there is still time to consider your options with a financial adviser, such as making gifts out of regular income, using trusts and utilising your Annual Exemption. If you’d like to make sure you’re taking the right steps to safeguard your financial future, please get in touch.
Pension investments can go down as well as up, and you may not get back the amount you originally invested. Access to pension funds is normally available from age 55 (rising to 57 in 2028), and any tax benefits depend on your individual circumstances and current HMRC rules, which are subject to change. Making retirement decisions without guidance carries risks. It is strongly recommended that individuals consult Pension Wise or seek regulated financial advice before making any decisions about their pension plans. This content is provided for information purposes only and does not constitute financial or investment advice.
Castlegate Financial Management Limited is registered in England No. 2077374. Registered Office: 8 Castlegate, Grantham, Lincolnshire. NG31 6SE. Authorised and Regulated by the Financial Conduct Authority. FCA No. 169777.
