Government confirms pensions will face inheritance tax: everything you need to know

The government has confirmed it will press ahead with plans that mean most unused pensions will be subject to inheritance tax from April 2027.

How you are affected will depend on the value of your pension when you die, your other assets and who you plan to leave them to.

The government expects the changes to impact 8% of estates. While that is a clear increase, it suggests that these changes won’t be felt by everyone. On the flip side, that figure is likely to underestimate the impact, as many people will change how and when they access their own pensions in their lifetime as a result of the move.

What pensions are included?

Most types of unused pensions and other pension death benefits will be included in the value of someone’s estate from April 2027 for the purposes of inheritance tax, but that doesn’t mean tax will always be due. There will be exceptions for dependant’s pensions paid from a defined benefit (e.g. final salary) pension scheme, survivors’ pensions paid under an annuity, as well as eligible lump sums paid to charities. Death in service lump sums that are tied to pension schemes will also be exempt if the person who died was still working.

What inheritance tax exemptions and allowances are there?

Other inheritance tax exemptions will also apply. The most valuable will be the ‘spousal exemption’ – which means anything left to a spouse or civil partner will be exempt from inheritance tax, including your pension.  

Pensions left to anyone else will only be subject to inheritance tax if the value of the estate is more than the available nil rate band and other allowances. Everyone can pass on up to £325,000 to others before inheritance tax applies thanks to the standard nil rate band, although this will continue to be frozen until at least 2030.

An additional £175,000 residence nil rate band per person is available where homeowners leave a property to their direct descendants, although for estates over £2 million this extra band begins to be tapered away. For married couples, this means up to £1 million can usually be passed on without inheritance tax when the second person dies. The main rate of inheritance tax is then 40%.  

Who will pay the inheritance tax?

One change to the original proposals on pensions being subject to inheritance tax is who is responsible for calculating and deducting the tax. HMRC has confirmed that – like for other assets – the personal representatives of an estate will initially be responsible for reporting and paying any inheritance tax due. This means any inheritance tax bill could be paid from other assets in the estate, but this might cause issues if the pension beneficiaries are not the same as those who inherited assets from other parts of an estate.  

A beneficiary can also ask the pension scheme administrator to pay the inheritance tax due directly from the scheme – but only the portion relating to the pension. The pension provider must do this if certain conditions are met, including that the inheritance tax bill for that pension is over £4,000.  

Will my beneficiaries also pay income tax?

Under current rules, income tax is paid by your pension beneficiaries (including a spouse or civil partner) on the money they withdraw if you die aged 75 or older. No income tax is payable if you die before reaching the age of 75.

That means if someone inherits a pension from someone who died over the age of 75 they will have to pay income tax at their own marginal rate on the money withdrawn. The changes could mean this is after any inheritance tax has already been deducted from the pension, leading to very high effective rates of tax on the money.  

Is there anything I can do now?

These changes are not due to come into force until 6 April 2027, and for deaths before this date pensions will usually remain outside an estate. Inheritance tax can already apply in some circumstances, such as where people transfer or make extra payments into pensions when they’re in very poor health.

It’s always good to keep your pension nominations under regular review, just like your will. Changing your beneficiaries could also help your estate’s tax position, but it really does depend on your personal situation. For example, if you’re happy your spouse or civil partner (if you have one) would be financially secure if you passed away, one option is to nominate other pension beneficiaries now, while your pension would still be exempt from inheritance tax. You might then change this back to your spouse closer to the changes in April 2027, to benefit from the spousal exemption.

Should I take money out of my pension?

It’s likely that people might start withdrawing money from their pensions to spend more on themselves while they are still alive, rather than leaving it in the account to pass on to future generations. This could be tax-free cash, taxable income or a mixture of the two. Other people are likely considering changing the order in which they take money from different types of accounts, for example switching to pensions first, before other accounts like ISAs. Previously many people left their pension as the last pot of money they touched, as it wasn’t subject to inheritance tax, instead depleting their ISAs and other accounts first, but this change removes that benefit.  

If you are already over the age of 75 then this could mean both inheritance tax and income tax being deducted from your unused pensions once you die. This could mean any tax-free cash you haven’t taken loses its tax-free status on your death. Everyone’s circumstances are different, but it will usually make sense to take any tax-free cash left by your 75th birthday.  

If you start taking an income from your pension or increase what you’re already taking, this income will be subject to income tax at your marginal rate. But if you’re passing the extra income on as a gift, it could prevent your beneficiary from facing both inheritance tax and income tax on anything you leave them from a pension, plus they benefit from your gift sooner. Read more about gifting from pensions.