Pensions have historically been a tax-efficient way to pass money on as they have been free from inheritance tax (IHT). But from 6 April 2027, most unused pension funds and certain pension death benefits are expected to be included in a person’s estate when liability for IHT is calculated.
If you’re approaching retirement, it’s worth understanding what’s changing and how it could affect your plans. After working hard to build your pension over the years, it’s natural to want to pass as much of your unused pension savings as you can on to the people you love.
This guide explains how IHT works, what the new pension rules mean and what to consider when planning your retirement income and the money you hope to leave behind.
This article is for general information only and is not personal tax or financial advice. Tax treatment depends on individual circumstances and may change. Consider taking advice from a qualified professional before making decisions about your pension or estate.
What is inheritance tax?
Inheritance tax is a tax that may be due on the money, property and other assets you leave behind when you die. These are known as your estate.
IHT is usually charged at 40% on the part of your estate that’s over the threshold. The amount due depends on the value of your estate, the allowances you can use and who you leave your assets to.
While inheritance tax often gets a lot of attention, it currently affects a relatively small number of estates. In fact, HMRC figures show IHT was payable on fewer than 1 in 20 estates (4.72%) in 2023/24.
How does inheritance tax work?
Most people have a standard IHT allowance called the nil-rate band. It is currently £325,000. This means IHT is generally only due on the part of your estate above that amount.
You may also qualify for an additional residence nil-rate band of up to £175,000 if you leave your home to your children (including adopted, fostered or step childen) or grandchild. This can increase the total allowance to £500,000 for an eligible individual, providing your estate is worth less than £2 million.
If you’re married or in a civil partnership, assets you leave to your spouse or civil partner are generally exempt from IHT. Any unused nil-rate band and residence nil-rate band may also be transferred to your surviving partner’s estate.
This means a couple could potentially pass on up to £1 million without IHT, if they qualify for both allowances and the conditions are met. The rules are more involved in some circumstances, so it is important to check how they apply to your estate.
The government’s guidance explains the nil-rate band and residence nil-rate band.
Inheritance tax allowances at a glance
Allowance | What it means |
|---|---|
Nil-rate band | £325,000 of your estate can usually pass on without IHT. |
Residence nil-rate band | Up to an extra £175,000 if you leave an eligible home to your children or grandchildren. |
Potential total | Up to £500,000 for someone who qualifies for both allowances. |
Couples and spouses | Married couples and civil partners can transfer any unused allowance to the surviving partner. |
How does inheritance tax apply to pensions today?
Right now, pensions are generally exempt from IHT. They’re usually held in a trust structure, which means they sit outside your estate for tax purposes. This generally applies to pension savings and death benefits paid to your loved ones as a lump sum or income.
The tax treatment can depend on how your pension is paid. Your beneficiaries may receive a lump sum, take money from a pension through drawdown or receive an ongoing annuity income, depending on the pension and its options.
Income tax may also apply. In general, inherited defined contribution pension benefits are usually tax-free if you die before age 75. If you die aged 75 or over, your beneficiaries will usually pay income tax on payments they receive, at their own rate. The rules can vary by benefit and circumstances, so check the details with your pension provider.
What is changing from 6 April 2027?
From 6 April 2027, most unused pension funds and certain pension death benefits from retirement income products will be included in your estate for IHT purposes. The changes will apply to deaths on or after this date, although some pension benefits will remain exempt.
What will be included in the estate?
Most unused defined contribution pension pots will count towards your estate, including money left in drawdown when you die, along with most pension death benefits. This may include some annuity death benefits, such as lump sums paid under a guarantee period.
Defined benefit pensions will generally be unaffected as they can’t be inherited as a fund. However, certain lump-sum death benefits from these pensions will be included.
Which pension benefits will remain exempt from IHT?
Some pension benefits will remain outside your estate for IHT. These include:
Pension benefits left to your spouse or civil partner, as they can inherit your entire estate tax-free.
Joint-life annuities, which pay an income to a spouse, civil partner or financial dependant after your death. They must have been purchased when your annuity was set up.
Dependants’ scheme pensions, death benefits paid to a dependent after you pass away.
Death-in-service benefits from registered pension schemes.
Certain charity lump sums paid under the relevant rules.
Defined benefit pensions, also known as ‘final salary’ pensions, that continue to pay an income to a spouse or civil partner after your death.
Joint-life annuities and IHT
Income from a joint life annuity that continues to be paid to your spouse or another eligible beneficiary after your death will remain exempt from IHT.
However, other annuity death benefits, such as lump sums paid under a guarantee period or value protection, may be included in your estate from April 2027. The tax treatment depends on the type of benefit and the terms of your annuity.
If you’re considering an annuity, Retirement Line’s specialists can explain the different options available, how they could provide an income in retirement and what benefits may be paid to loved ones after your death.
Pension benefit | Expected IHT treatment |
|---|---|
Unused pension funds, including money in drawdown | Generally included |
Pension lump-sum death benefits | Generally included |
Lump sums paid under an annuity guarantee period or value protection | Generally included |
Joint life annuity payments continuing after death | Excluded |
Qualifying dependants’ scheme pensions | Excluded |
Qualifying death-in-service benefits | Excluded |
Benefits left to a spouse or civil partner | Generally exempt |
Benefits left to a registered charity | Generally exempt, subject to the rules |
The exact treatment of a pension benefit can depend on the scheme and the rules governing the payment.
Could an inherited pension face both inheritance tax and income tax?
It’s possible. IHT and income tax are separate, so being exempt from one doesn’t automatically mean a pension is exempt from the other.
The income tax your loved ones pay on an inherited pension depends on your age when you die and how the money is paid.
Generally, if you die before age 75, inherited pension benefits can be taken tax-free, provided the relevant conditions are met.
If you die aged 75 or over, your beneficiaries will usually pay income tax on taxable pension payments they receive, at their marginal rate.
From April 2027, inherited pension savings may also count towards your estate for IHT. This means IHT could be due on the pension when you die, and your loved ones may also have to pay income tax on withdrawals they make later.
An illustrative example
The table below illustrates how a £100,000 pension fund could be affected if a pension holder dies after age 75 and both inheritance tax (IHT) and income tax apply.
Stage | Amount |
|---|---|
Pension fund | £100,000 |
IHT at 40% | £40,000 |
Amount remaining | £60,000 |
Income tax at 40% on a taxable withdrawal | £24,000 |
Amount left after both taxes | £36,000 |
In this example, the combined tax is 64% of the original fund. If the beneficiary’s income tax rate were 45%, the combined amount would be higher.
This is only an illustration. In practice, IHT is calculated on the estate as a whole. Available allowances may reduce or remove the IHT due, and income tax depends on the beneficiary’s circumstances and how the pension is paid.
It’s also worth knowing about the lump sum and death benefit allowance (LSDBA). For the 2026/27 tax year, the standard LSDBA is £1,073,100, although the amount available may be reduced if you've already taken tax-free lump sums from your pensions.
If a lump sum exceeds the available allowance, the excess will usually be taxed at the recipient's marginal rate of income tax. Whether this applies will depend on your circumstances, the type of death benefits paid and how much of your LSDBA remains available.
What could the changes mean if you’re approaching retirement?
If you’re planning to retire soon, the changes may be one more factor to consider when deciding how to use your pension. They shouldn’t be the only factor.
Your pension is there to support you in retirement. You’ll need to balance the income you want during your lifetime with any plans you have to leave money to family or other beneficiaries.
If you haven’t taken your pension yet
Before choosing how to take your pension, think about the income you’ll need, whether you want to leave money to someone and how your choice could affect your estate.
An annuity can provide a guaranteed income, often for life. Depending on the options you choose, it may also provide an income for a spouse or dependant after you die. A drawdown arrangement gives you more flexibility over withdrawals, but the remaining fund stays invested and its value can rise or fall.
Here at Retirement Line, we specialise in annuities. If you’re comparing an annuity with drawdown, our specialists can help you understand the options available and the guaranteed income that each could provide.
If you’re already taking pension income
If you’re using drawdown, you may still have money invested in your pension. From April 2027, most unused funds are expected to count towards your estate for IHT.
That doesn’t automatically mean you should withdraw more. Taking money out of a pension can affect your income tax, the way your savings are invested and how long your money lasts. Money you withdraw may also become part of your estate, depending on what you do with it.
If you’re thinking about leaving money to loved ones
Consider what you want your pension to provide for you first. You may want to leave an inheritance, but you also need to make sure you have enough income for your own retirement.
If passing on pension benefits is important to you, check who your pension provider could pay them to and how the benefits would be taxed. You may also want to review your expression of wish form, which tells your pension provider who you would like to receive your pension benefits. It may not be legally binding, and the scheme’s rules still apply.
How can you prepare for the 2027 changes?
You don’t need to make a rushed decision. The changes are a reason to review your plans and understand how your pension fits into your wider finances.
Take stock of your estate. Add up your savings, investments, property and other assets. Consider how your pension could affect the total from April 2027. With inheritance tax currently only affecting around 4% of estates, this will help you understand whether the proposed changes are likely to have any impact on you.
Check which IHT allowances may apply. Your spouse or civil partner, home and intended beneficiaries can all affect the allowances available.
Review your pension arrangements. Check what benefits could be paid when you die and who may receive them. Ask your provider how the new rules are expected to affect your scheme.
Think carefully about how you take your pension. Annuity and drawdown choices affect your retirement income as well as what may be left for others. Don’t make a decision based on IHT alone.
Consider the income tax position too. The tax a beneficiary may pay on pension withdrawals can depend on your age at death and the type of benefit.
Get advice if you need it: A qualified tax or financial adviser can help you understand the effect on your estate. If you’re considering an annuity, Retirement Line’s specialists can help you explore your options.
What’s the key point to remember?
From 6 April 2027, most unused pension funds and certain pension death benefits are expected to be included in your estate for inheritance tax. But whether your beneficiaries pay IHT will depend on the value of your estate, the allowances available and who inherits.
If you’re approaching retirement, it’s worth looking at your pension as part of your wider financial plans. Make sure you understand the income you may need, the options available and what you hope to leave to loved ones.
Frequently asked questions
Will my pension be subject to inheritance tax from April 2027?
Most unused pension funds and certain pension death benefits are expected to be included in your estate for IHT if you die on or after 6 April 2027. Whether tax is due will depend on your estate’s value, available allowances and who receives the benefits. Some pension benefits and transfers to a spouse or civil partner are expected to remain exempt.
How much of my estate can I pass on without inheritance tax?
The standard nil-rate band is £325,000. You may qualify for an additional residence nil-rate band of up to £175,000 if you leave your home to your children or grandchildren. This could give you a total allowance of £500,000. A surviving spouse or civil partner can also use unused allowances from their partner, subject to the rules.
Are annuities subject to inheritance tax?
It depends on the annuity and the benefit paid after you die. Some qualifying ongoing payments to a dependant or nominee are expected to remain exempt. Other annuity death benefits, such as certain guarantee-period lump sums, may be included in your estate. Check the terms of your annuity and the tax rules that apply.
Will someone who inherits my pension also pay income tax?
They may. The income tax treatment depends on your age when you die, the type of pension benefit and how the beneficiary takes it. In broad terms, inherited pension benefits are often tax-free if you die before age 75, subject to conditions. If you die aged 75 or over, taxable withdrawals are generally taxed at the beneficiary’s income tax rate. From April 2027, IHT may also apply to the pension before it is inherited.
Should I choose an annuity or drawdown if I want to leave an inheritance?
There isn’t one right answer. An annuity can provide a guaranteed income, and some options can pay an income to a spouse or dependant after you die. Drawdown gives you flexibility, but the remaining pension stays invested and its value can change. Think about your own retirement income first, then consider what you want to leave behind and how the tax rules may affect it. Retirement Line’s annuity specialists can help you compare annuity options and understand the income they could provide.
