Since the introduction of pension freedoms in April 2015, pensions have offered a flexible way to fund retirement. For those who do not need all of their pension savings to fund retirement income, unused funds can be passed on to future generations without an inheritance tax (IHT) charge.
Following announcements in the October 2024 Budget, and the Finance Act 2026 receiving Royal Assent, the tax rules will change from April 2027, when unused pension funds will form part of a person’s estate for IHT purposes. While pensions remain a valuable component of long-term financial planning, the new rules are likely to prompt many individuals and families to reconsider how pension assets fit within their broader wealth transfer strategy. A knock-on effect is that there will be greater complexity when it comes to estate administration.
Unused pension funds are currently outside the scope of IHT and will remain so until the new rules begin in April 2027. While there are some exceptions to this for certain so-called legacy pension arrangements, under the current rules, the main factor is whether death occurs before or after age 75, as this determines how pension death benefits are taxed:
A similar distinction applies if you have an annuity and pass away:
Where pensions were once IHT-efficient vehicles for wealth transfer, HMRC’s stated aim is to curb their use as a tax planning tool and restore their primary function as retirement savings. With these changes, pensions will largely be treated like other estate assets for IHT, removing the broad protection they once offered, and will require individuals to reassess their wealth planning.
Certain exclusions remain:
| Excluded pension death benefits | Factors to consider |
| Benefits payable to charity | The charity must be a UK-registered charity. Leaving 10% of a net estate to charity may also reduce the IHT rate payable by the estate from 40% to 36%. |
| Dependants’ Scheme Pension | This is most relevant for defined benefit pension arrangements. However, in the case of money purchase occupational schemes, a dependant’s pension is exempt from IHT. |
| Joint Life Annuities | The survivor’s pension is excluded regardless of relationship to the deceased, that is, the survivor doesn’t need to be the spouse in a Joint Life Annuity. |
| Death In Service | Excluded whether discretionary nomination or fixed beneficiary. |
| Non-UK Pensions | Since April 2025, UK IHT has been based on long-term UK residence. As a result, individuals who are not long-term UK residents may not be liable to UK IHT on their non-UK pensions. |
Source: Pensions and IHT
When the lifetime allowance (LTA) was abolished on 6 April 2024, it was replaced by two new limits on the amount of pension benefits that can be paid tax-free as lump sums. These are known as the Lump Sum Allowance (LSA) and the Lump Sum and Death Benefit Allowance (LSDBA).
Lump sums paid within the available LSDBA amount are usually tax-free. Any amount above the available LSDBA is normally taxed as income on the recipient even if death occurred prior to age 75. By contrast, death benefits paid as a pension, such as beneficiary income drawdown, would not use any of your LSDBA.
The new rules mean there is generally no longer a tax distinction between death benefits from pensions funds that have been accessed and those that have not (although some funds accessed before 6 April 2024, may be treated differently). For those who are looking to transfer unused pension funds to future generations, a scheme that offers both a lump sum option, as well as beneficiary income drawdown may be particularly beneficial.
There will be an increased administrative burden associated with estate management following a death, owing to the imminent inclusion of pensions as part of an individual’s estate. We briefly touched on this in our previous article, Pensions and IHT in August 2025, with the key change being a shift of burden of reporting and paying of the IHT liability largely to the personal representatives (PRs) of the estate rather than the pension scheme administrators (PSAs).
Our Wealth Planning team will share a detailed guide to these administrative changes in the coming weeks.
Clients aged 75 or older who are yet to touch their pension funds should consider taking their tax-free lump sum. If the money is left in the pension and passed to a beneficiary who is not exempt from IHT, the funds could be subject to IHT and the residual fund could then also be subject to income tax when the beneficiary withdraws it.
The IHT spouse exemption will still apply. This is why it is important to keep pension nomination forms up to date so that, subject to pension trustees’ discretion, benefits can pass in line with the individual’s wishes. Where the nominated beneficiary is a surviving spouse or civil partner, no IHT will be payable on first death.
For those wishing to leave a legacy in their will to a charity, a consideration may be to nominate a registered charity to receive a legacy from their pension fund, as this is also exempt from IHT.
In cases where there is no beneficiary nominated and a surviving financial dependant, such as a spouse, is still alive, the scheme administrators would most likely only pay out a lump sum rather than make beneficiary income drawdown available. This could create unintended tax consequences if the amount of the lump sum exceeds the available lump sum in the case of a pre-age 75 death or, make the whole lump sum subject to income tax in the case of a post-age 75 death.
The options available on death depends on the scheme rules as not all schemes would be able to facilitate beneficiary income drawdown. Proactive preparation can ensure the most efficient approaches are used.
Where pension income can be withdrawn at a lower tax rate than the 40% IHT payable on death, it may make sense to use more of the pension during retirement rather than leaving it untouched.
The use of the retirement pension pot, or some of the pension pot, to fund an annuity should also not be disregarded. Following improved rates in recent years, an annuity can provide a secure and predictable source of income throughout retirement, in the right circumstances.
As unused pension funds move into the IHT bracket in April 2027, ongoing reviews of nominations, retirement income strategies and the use of tax-free cash at the appropriate time will become increasingly important. For many individuals and families, adopting a proactive approach to financial planning and wealth transfer can help ensure their arrangements continue to support both retirement and legacy goals under the new rules.
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