Pensions and Inheritance Tax: The 2027 Changes

For years, financial advisers gave the wealthier retiree a quiet piece of guidance: spend your ISAs and savings first, and leave your pension untouched, because a pension passed outside your estate and escaped inheritance tax. That logic is about to be turned on its head. From 6 April 2027, unused pension funds will be brought within the scope of inheritance tax, one of the most consequential changes to retirement planning in a generation.

This guide explains what is changing, how pensions are taxed on death today, how the two taxes could stack from 2027, and the practical steps worth considering now. It is general information, not personal advice; the figures are correct for 2026 and the value of an invested pension can rise or fall.

How pensions pass on today

Under the rules in force for 2026, most defined contribution pensions are held outside your estate. When you die, the fund passes to whoever you have nominated, and whether income tax applies depends on your age at death. Die before 75 and your beneficiaries can usually take the money free of income tax; die at 75 or later and they pay income tax at their marginal rate on whatever they withdraw.

Crucially, inheritance tax has not applied to these pensions. That is precisely why pensions became such a favoured way to pass wealth down the generations: a pot left untouched could cascade to children and grandchildren without the 40% charge that hits the rest of a large estate. From April 2027, that gap closes.

This treatment made pensions unusually powerful as an estate-planning tool. A retiree with both an ISA and a pension was often advised to live off the ISA, which does count towards the estate, while leaving the pension to grow and pass on outside it. The pension effectively became a tax-privileged inheritance vehicle as much as a retirement fund. It is that dual role the Government is now unwinding, on the view that pensions were never intended to be a shelter for passing on wealth.

What changes in April 2027

The core change is simple to state and far-reaching in effect: from 6 April 2027, unused pension funds and most pension death benefits will be included in the value of your estate for inheritance tax purposes. Where the whole estate exceeds the available nil-rate bands, the excess, including the pension element, is taxed at 40%. The income-tax rules on death (the age-75 dividing line) are expected to continue alongside this, not replace it.

For modest estates that already sit within the nil-rate bands, nothing may change. But for anyone whose combined assets, home, savings, investments and now pension, climb above the thresholds, a pension that once passed cleanly could suddenly attract a substantial bill. It is a change that pushes many people to rethink the order in which they spend their retirement money.

Consider a straightforward example. A widow dies with a £500,000 home, £150,000 of ISAs and a £400,000 unused pension, a little over £1 million in total. Under the rules up to April 2027, the pension sits outside her estate, and the rest may be largely covered by her own and her late husband’s combined nil-rate bands. From April 2027 the pension is added back in, potentially pushing the estate well above the available allowances and creating a 40% charge on the excess where none existed before. The numbers are illustrative, but the direction of travel is clear.

The reform also changes the administrative burden. Pension scheme administrators and personal representatives will need to coordinate so that any inheritance tax due on a pension is calculated and settled correctly, which may lengthen the time before beneficiaries receive funds. Getting your paperwork, nominations, an up-to-date will, and a clear record of your pensions, in order now will make that process smoother for the people you leave behind.

When two taxes stack

The most painful scenario is where inheritance tax and income tax apply to the same pension. Imagine someone dying at 75 or older with a large unused pot. From April 2027 the fund could first be reduced by inheritance tax at 40% within a taxable estate, and then the beneficiary pays income tax at their own rate on what remains when they draw it. The combined effect on the top slice can be severe.

This is illustrative rather than a calculation for any individual, and reliefs and the order of set-off matter. But it shows why the reform changes behaviour: a pension is no longer automatically the last pot you should touch. For some, drawing a sensible income and enjoying their own money, or using it to help family within the gift rules, becomes more attractive than hoarding it to pass on.

The age-75 threshold sharpens this further. Someone in good health at 74 with a large unused pot and a taxable estate faces a genuine planning question: money drawn now is taxed at their own income-tax rate, but money left to a beneficiary after 75 is taxed at the beneficiary’s rate, which could be higher if they are working, and may also face inheritance tax. There is no one-size answer, but it is the kind of trade-off that rewards sitting down with the numbers well before it becomes urgent.

The nil-rate bands

Inheritance tax is charged at 40% on the value of an estate above the available allowances. The standard nil-rate band is £325,000 per person, and the residence nil-rate band adds up to a further £175,000 where a main home passes to direct descendants. Both are frozen until 2030. A married couple or civil partners can combine and pass on unused bands, giving a potential £1 million before any tax is due.

Because these bands are frozen while asset values and pensions grow, more estates drift into the net each year, a process sometimes called fiscal drag. Adding pensions to the mix from 2027 accelerates it. Our guide to the inheritance tax threshold explains how the bands are applied, and the fuller inheritance tax planning guide shows how they fit into a wider estate plan.

It is worth knowing that the residence nil-rate band also tapers away for larger estates: once an estate exceeds £2 million, the £175,000 residence allowance is reduced by £1 for every £2 above that line, vanishing entirely at around £2.35 million. Folding a sizeable pension into the estate from 2027 could tip some families over this threshold and quietly strip out an allowance they were previously relying on, another reason the change reaches further than the headline suggests.

What you can do now

• 1

  Revisit your spending order

  The old “pension last” default may no longer be optimal. Model whether drawing more pension income earlier, and preserving other assets, reduces the overall tax on your estate.

• 2

  Use your gift allowances

  Gifts within the annual and normal-expenditure-out-of-income rules, and gifts that survive seven years, can move wealth out of your estate over time.

• 3

  Enjoy your own money

  A pension is there to fund your retirement. Spending it on the life you planned is itself a legitimate, and now more tax-efficient, response.

• 4

  Keep spousal transfers in view

  Everything left to a spouse or civil partner remains exempt, and unused nil-rate bands pass between them.

• 5

  Take regulated advice

  The interactions are genuinely complex and the stakes are high. This is a case for personal, FCA-regulated advice, not a rule of thumb.

How you take income also feeds into this: the choice between drawdown and an annuity affects how much of your pot remains as an unused fund on death. And broader steps in our guide to reducing inheritance tax legally apply here too.

Nominations and spouses

One piece of housekeeping matters more than ever: your expression of wish, or beneficiary nomination, tells the pension scheme who should receive the fund. Keeping it current, after a marriage, divorce, or new child, ensures the money reaches the right people and can be dealt with tax-efficiently. An out-of-date nomination can undo careful planning in an instant.

Transfers between spouses and civil partners remain exempt from inheritance tax, so for many couples the first death still passes assets on tax-free, with planning focused on the second. But the detail of how the 2027 rules apply to pension death benefits is exactly the kind of area where professional advice earns its keep.

A final word of caution against knee-jerk reactions. The temptation, on reading about the 2027 change, is to strip money out of pensions quickly to “get ahead of it”. That can be a serious mistake: large withdrawals can trigger income-tax bills of their own, lose the tax-free growth the pension still offers, and move money into your estate where it may be more exposed, not less. The right response is rarely a rushed withdrawal: it is a considered plan that weighs income tax, inheritance tax and your own spending needs together. Investments can fall as well as rise, and this remains general information rather than advice for your circumstances.

The 2027 change makes joined-up pension and estate planning more valuable than it has been in years. Vetted Wealth can match you, free of charge, with an independently vetted, FCA-regulated adviser who handles both, start with our pension advice overview.

Common questions on pensions