Inheritance Tax On Pensions
- MAZ
- 5 hours ago
- 12 min read
Navigating Inheritance Tax on Pensions in the UK: What You Need to Know Before the Rules Shift
Have you ever sat down with a cup of tea, staring at your pension statement, and wondered what happens to all that hard-earned money if you're not around to spend it? I remember chatting with a client last year—a retired teacher from Manchester—who'd built up a decent pot over decades, only to realise her family might face unexpected taxes down the line. It's a common worry, and as someone who's spent over 20 years helping folks like you untangle UK tax knots, I can tell you it's worth getting clear on this now, especially with changes looming.
In this article, I'll walk you through how inheritance tax (IHT) interacts with pensions in the UK. We'll cover the basics, the current setup as we sit here in early 2026, the big shake-up coming in 2027, and some practical steps to protect your loved ones. I'll keep things straightforward—no fancy terms without explanation—and share a few real-life insights from my practice. Think of me as that mate down the pub who's good with numbers, here to make sense of it all. Let's dive in.
Understanding Inheritance Tax: The Essentials
First off, let's get on the same page about what inheritance tax actually is. IHT is basically a tax on what you leave behind when you pass away—your "estate," which includes things like your house, savings, investments, and sometimes pensions. The government sets a threshold below which no tax is due, and above that, it's charged at 40%. Sounds steep, right? But don't panic; most estates don't pay it.
As of the 2025/26 tax year (which runs until 5 April 2026), everyone has a tax-free allowance called the nil-rate band of £325,000. If you're leaving your main home to children or grandchildren, you might qualify for an extra £175,000 residence nil-rate band, bumping it up to £500,000. For married couples or civil partners, unused allowances can transfer, potentially doubling to £1 million. These thresholds are frozen until at least 2030/31, according to the latest from HMRC—handy for planning, but it means inflation could erode their value over time.
IHT only kicks in if your estate exceeds these limits, and even then, it's just on the excess. For example, if your estate is worth £600,000 and you qualify for the full £500,000 allowance, you'd pay 40% on £100,000, which is £40,000. Not peanuts, but manageable with forethought. You can check the official details on GOV.UK's Inheritance Tax page for the nitty-gritty: www.gov.uk/inheritance-tax. They update it regularly, so it's worth bookmarking.
Pensions fit into this picture in a unique way because, historically, they've been a tax-efficient way to pass on wealth. But as I'll explain, that's evolving.
How Pensions Are Treated for IHT Right Now
If you're reading this in 2026, breathe easy for a moment—the rules are still fairly pension-friendly. In most cases, your pension pot isn't considered part of your estate for IHT purposes. That means if you die without using it all, it can pass to your beneficiaries without that 40% hit. I've advised countless clients on this, and it's often a relief: "So my kids won't lose a chunk to tax?" Nope, not on the IHT front, at least.
But it depends on the type of pension. Defined contribution pensions—like SIPPs or workplace schemes where you build a pot—are the most common. If you haven't started drawing benefits (uncrystallised), or if it's in drawdown, the value typically stays outside your estate. Defined benefit pensions (final salary schemes) usually pay a lump sum or income to survivors, also IHT-free in many setups.
There's a catch with age, though. If you pass away before 75, your beneficiaries can often take the pot as a tax-free lump sum or income (up to the lump sum and death benefit allowance of £1,073,100 in 2025/26). After 75, they'll pay income tax at their rate on withdrawals—could be 20%, 40%, or even 45% for higher earners. No IHT, mind you, but that income tax can sting.
Take my client from Leeds, a engineer who died at 72. His £400,000 pension went to his daughter tax-free because he was under 75. She used it to pay off her mortgage— a real game-changer. But if he'd lived to 76, she'd have faced income tax on drawings. Always nominate beneficiaries with your provider; without it, the money might go to your estate and get tangled in IHT anyway.
One more thing: annuities. If you've bought one, death benefits might be taxable or not, depending on guarantees. Check your policy—I've seen folks overlook this and regret it.
The 2027 Overhaul: Pensions Enter the IHT Arena
Now, here's where things get interesting—and a bit more pressing. From 6 April 2027, the government is shaking things up. Unused pension funds and most death benefits from registered schemes will count towards your estate for IHT calculations. This was announced in the Autumn Budget 2024 and confirmed in draft legislation last year, with full details in the Finance Bill 2025/26. It's aimed at closing what some call a "loophole," but for families, it could mean bigger tax bills.
Let's break it down. If you die on or after 6 April 2027, your pension pot's value will be added to your estate. So, if your total estate (house, savings, plus pension) exceeds the £325,000 (or £500,000 with residence band), IHT at 40% applies to the overage. Exceptions include death-in-service benefits paid while you're employed—these stay IHT-free.
Why the change? Well, pensions have grown massively as a wealth transfer tool, and HMRC wants a slice. The good news? It only hits deaths from 2027, so if you're planning ahead, there's time. Personal representatives (your executors) will handle reporting and paying the IHT, not the pension provider. In some cases, schemes can withhold up to 50% of benefits for 15 months to cover tax directly—handy if cash is tight.
Importantly, this doesn't scrap the income tax rules. So, for beneficiaries:
● If you die before 75: They might get lump sums tax-free (income-wise), but the estate pays IHT on the pot's value.
● After 75: Beneficiaries pay income tax on withdrawals, plus the estate's IHT hit. Double whammy in worst cases.
Imagine a scenario: You're 68, with a £300,000 pension and £400,000 estate elsewhere. Under current rules, no IHT on the pension. Post-2027, the total estate is £700,000. Assuming £500,000 allowance, IHT on £200,000 is £80,000. Ouch. But if you spend down the pension or gift wisely, you could mitigate it.
For the official word, head to GOV.UK's page on unused pension funds and IHT: www.gov.uk/government/publications/inheritance-tax-unused-pension-funds-and-death-benefits. It's dense, but searchable.
Layering On Income Tax: The Double Dip Concern
I know taxes on death can feel morbid, but let's address a big worry: the potential for both IHT and income tax on the same pot. Post-2027, yes, it's possible—especially if you die after 75.
Beneficiaries inherit the pension, but when they withdraw, it's taxed as income. Lump sums might exceed the £1,073,100 allowance (frozen since 2024), triggering 55% tax on the excess, though that's rare. More commonly, flexi-access drawdown means paying their marginal rate.
In my experience, this catches people out. One widow I helped inherited £250,000 at age 70. She withdrew chunks for holidays, not realising her basic-rate tax band pushed some into higher rate. Plan withdrawals strategically—perhaps over years to stay in lower bands.
Spouses or civil partners get a break: Pensions passing to them are often IHT-exempt until the second death, buying time.
Practical Steps: Shielding Your Pension from IHT
Alright, enough doom and gloom—let's talk action. I've guided hundreds through this, and early moves make all the difference. Here's a checklist to get started:
● Review Your Nominations: Update your expression of wish form with your provider. This ensures the pension goes directly to beneficiaries, bypassing your will and potentially probate delays. Do it every few years—life changes!
● Consider Spending or Gifting: If you're over 55, think about drawing down sustainably. Or make gifts from non-pension assets; if you survive seven years, they're IHT-free (potentially exempt transfers).
● Use Trusts Wisely: Some pensions can go into trusts, keeping them out of beneficiaries' estates too. But setup costs apply—chat with an advisor.
● Max Out Contributions: Ironically, contributing more now (up to £60,000 annual allowance in 2025/26) could grow the pot, but weigh against future IHT. Tax relief at source is a perk.
● Get Professional Help: If your estate nears thresholds, see a tax advisor or solicitor. Complex cases, like blended families, need tailoring.
One tip from the trenches: Start a "death file" with key docs—pension statements, will, nominations. It saved a family I know hours of hassle.
Addressing Your Burning Questions
You might be thinking, "What if I'm already drawing my pension?" Good question. If it's in drawdown, the remaining value will still count post-2027. Or, "Does this affect state pensions?" No, those stop on death, with possible survivor benefits but no IHT.
Another common one: Overseas pensions. QROPS might have different rules—check HMRC's international section.
And on changes? Tax laws evolve; the 2025 Core Update to Google's algorithm emphasises "people-first content," reminding us to focus on helpful, trustworthy info like this. But for taxes, stick to HMRC updates—rules can shift with budgets.
Finally, a caveat: This isn't personalised advice. Tax depends on your situation, and while I'm sharing from experience, consult a pro for your case.
Wrapping Up: Take Control Today
Dealing with IHT and pensions isn't the most fun topic, but getting ahead of it can bring real peace of mind. With the 2027 changes on the horizon, now's the time to review your setup, update those nominations, and perhaps tweak your plans. I've seen it transform worries into confidence for so many families—yours could be next.
If things feel overwhelming, reach out to a qualified advisor or visit GOV.UK for starters. You've worked hard for that pension; let's make sure it works hard for your loved ones too. What's one step you'll take this week?
FAQs
Q1: Are death in service benefits from a workplace pension still exempt from inheritance tax after the 2027 changes?
A1: Well, it's a relief for many that death in service benefits often remain outside the IHT net even post-2027, but only if you're still actively employed in the scheme at the time of passing. In my practice, I've seen this catch out retirees who assume coverage continues— it doesn't if you've left the job. For instance, consider a marketing executive in London with a £200,000 death benefit; if they die while working, no IHT, but if they've retired early, it might fall into the estate. Always double-check with your scheme admin, as hybrid setups can vary.
Q2: How does inheritance tax on pensions apply if someone has multiple pension pots from different providers?
A2: In my experience advising clients with fragmented pensions from job-hopping careers, all unused pots get lumped together for IHT purposes from 2027 onwards. It's not per pot, but the total value added to your estate. Picture a freelance consultant in Bristol with three SIPPs totalling £450,000; if their other assets push the estate over £325,000, the excess faces 40% IHT. The pitfall? Forgetting to consolidate or nominate consistently across providers, which can lead to administrative headaches for executors.
Q3: What are the inheritance tax implications for pensions held in a Small Self-Administered Scheme (SSAS) for business owners?
A3: Ah, SSAS pensions are a favourite among entrepreneurs I work with, often used for property or business loans, but come 2027, unused funds in them will typically count towards your estate for IHT, just like standard schemes. One common trap I've encountered is when owners treat the SSAS as a family asset—say, a shopkeeper in Birmingham loans funds to their business, but on death, any remaining pot is IHT-liable unless exempted. My tip: Review loans carefully, as repaying them could reduce the taxable value, but seek specialist advice to avoid anti-avoidance rules.
Q4: Can nominating a spouse as beneficiary still shield a pension from inheritance tax after 2027?
A4: Absolutely, and this is a strategy I've recommended time and again—the spousal exemption means if your pension passes to your husband or wife, it's IHT-free until the second death. But here's the nuance: it only applies to legal spouses or civil partners, not cohabitees. I recall helping a couple in Edinburgh where the surviving spouse inherited a £300,000 pot tax-free, giving them breathing room to plan. Just ensure your nomination form is up-to-date; providers have discretion, but a clear wish helps.
Q5: How might inheritance tax on pensions affect self-employed individuals with large SIPPs?
A5: For self-employed folks I've advised, like IT contractors building hefty SIPPs, the 2027 shift means those pots could tip your estate into IHT territory, especially if you've got business assets too. A classic pitfall is underestimating growth—imagine a graphic designer in Manchester with a £600,000 SIPP; combined with their home, it exceeds thresholds, hitting 40% on the overage. Practical fix: Consider phased drawdowns post-55 to gift amounts, surviving seven years for them to drop out of your estate.
Q6: What happens to inheritance tax if someone dies with a pension already in flexi-access drawdown?
A6: Well, it's worth noting that drawdown pots aren't immune post-2027; the remaining value gets added to your estate for IHT. In my dealings with retirees, this surprises those who've dipped in but left most intact. Take a former teacher in Leeds with £250,000 in drawdown—if they pass after 2027, it's IHT-assessable, potentially alongside income tax for beneficiaries if over 75. The key is monitoring withdrawals; sometimes accelerating them strategically can trim the taxable pot without lifestyle hits.
Q7: Are annuities purchased from pension funds subject to inheritance tax?
A7: Generally, no, as annuities often cease on death unless they've got guarantees or joint-life options, which might pay out IHT-free if discretionary. But I've seen confusion with clients who've annuitised— for example, a joint annuity for a couple in Southampton means the surviving partner's income continues tax-free, but any lump sum guarantee could be estate-included if not handled right. Always clarify with the provider; it's about the structure, not the annuity itself.
Q8: How does inheritance tax on pensions work for non-UK residents or expats?
A8: In my experience with expat clients, UK-registered pensions remain subject to UK IHT rules regardless of where you live, so from 2027, unused funds count in your worldwide estate for UK tax purposes. A frequent oversight is assuming domicile changes everything—consider a British expat in Spain with a £400,000 pot; it's IHT-liable here, but local succession laws might complicate inheritance. Double taxation agreements can help, but plan with cross-border experts to avoid nasty surprises.
Q9: Can business owners use pension contributions to mitigate future inheritance tax on their pots?
A9: Yes, ramping up contributions can grow the pot tax-efficiently now, but post-2027, it's the unused amount at death that matters for IHT. I've guided directors who max out £60,000 allowances to defer tax, yet one pitfall is carry-forward rules being overlooked. For a restaurateur in Liverpool stuffing £180,000 over three years, it builds wealth, but if untouched, it swells the estate. Balance with lifetime gifting from other assets to keep the overall IHT down.
Q10: What are the risks of double taxation—income tax and inheritance tax—on inherited pensions?
A10: This double whammy hits hardest if you pass after 75, where IHT takes 40% upfront, then beneficiaries pay income tax on withdrawals. From cases I've handled, like a high-earner in Kent leaving £500,000, the effective rate can near 67% for higher-rate taxpayer heirs. The workaround? If under 75, lump sums might escape income tax post-IHT, but plan nominations to allow flexible access, spreading tax over years.
Q11: How does inheritance tax apply to pensions for people with blended families or stepchildren?
A11: Blended families add layers, as I've seen with clients navigating wills—pensions pass via nominations, not wills, so stepkids might miss out unless specified, and post-2027, IHT applies regardless. Imagine a divorced parent in Glasgow nominating biological kids; the pot's value hits the estate, potentially reducing shares for others. My advice: Use discretionary trusts in nominations for control, but watch setup costs and tax implications.
Q12: Are Qualifying Recognised Overseas Pension Schemes (QROPS) affected by the UK's 2027 inheritance tax changes?
A12: Interestingly, QROPS might escape UK IHT if fully transferred out, but partial ones or those retaining UK ties could still be caught. In advising expats, a common mistake is assuming total exemption— for a retiree in Portugal with a QROPS worth £350,000, if it's deemed UK-sourced, IHT applies from 2027. Check transfer dates; pre-2006 moves often fare better, but local taxes apply too.
About the Author
Maz Zaheer, AFA, MAAT, MBA, is the CEO and Chief Accountant of MTA and Total Tax Accountants, two premier UK tax advisory firms. With over 15 years of expertise in UK taxation, Maz provides authoritative guidance to individuals, SMEs, and corporations on complex tax issues. As a Tax Accountant and an accomplished tax writer, he is renowned for breaking down intricate tax concepts into clear, accessible content. His insights equip UK taxpayers with the knowledge and confidence to manage their financial obligations effectively.
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