UK Inheritance Tax Set to Affect Pension Funds from 2027 – What You Need to Know

From 6 April 2027, The UK government has announced that most unused pension funds and death benefits will fall under the scope of Inheritance Tax (IHT).  If this goes ahead, it will mark a significant change in estate planning. Historically, pensions have been a popular way to transfer wealth to the next generation free from IHT, but this could be about to change. 

The aim of the policy is to ensure pension tax relief is used for retirement income, rather than as a vehicle for tax-free wealth transfer. And while the consultation has received significant criticism, the government appears keen to move forward with the changes, albeit with some adjustments to the original plan.

What does this mean for you?

Staying up to date with potential changes is an important part of long-term financial planning. While some changes are out of your control, there are steps you can take to protect your wealth and ensure your estate is managed as efficiently as possible. Below, I’ve outlined the key points of the new rules, highlighted important international considerations, and suggested actions you can take now to prepare..

Key Changes to Pensions and IHT From April 2027

1. Unused pension funds will be counted as part of your estate for IHT
   From 6 April 2027, any unused pension savings or lump-sum death benefits will be included when calculating your estate’s IHT liability. Essentially, most pension wealth will no longer be protected from the 40% inheritance tax. This applies to both defined contribution pensions and lump-sum benefits from defined benefit schemes that would have previously been outside your estate.
   
   
2. No minimum threshold for small pensions
   Unlike some taxes that ignore smaller amounts, there’s no exemption here for smaller pension pots. Every penny of unused pension could be subject to IHT. Even if no IHT is due (for example, if your estate is under the nil-rate band or passes to exempt recipients), your family or executors will still need to report the pension in the IHT paperwork. This means even modest estates could face extra paperwork.
   
   
3. Executors, not pension providers, will report the tax
   One helpful update is who will report and pay the IHT on pension assets. Initially, this responsibility was going to fall on pension providers, but that wasn’t practical. Now, it will be the responsibility of the personal representatives (PRs), or your estate executors. They’ll report the pension’s value and settle any IHT due. While it makes the process more consistent, it also means your family will handle the tax rather than the pension provider.
   
   
4. Beneficiaries can be held liable for unpaid tax
   Pension beneficiaries will be jointly responsible for any unpaid IHT on the pension funds they inherit. If the executor doesn’t settle the tax, HMRC can go after the beneficiaries for the unpaid amount. This makes it crucial to get the tax right during estate administration.
   
   
5. Pension schemes may deduct tax (if requested)
   Although the executors are responsible for the IHT, beneficiaries can choose to have the pension scheme pay the IHT directly from the pension funds before they receive the remaining balance. However, this will only apply if the IHT bill is over £4,000. If it’s lower, the executors will take care of the tax.
   
   
6. Good news: Death-in-service benefits are exempt from IHT
   Employer-provided death-in-service benefits will remain exempt from IHT. These benefits are usually paid as a lump sum if an employee passes away while working, and the government has clarified that these benefits will not be subject to IHT, whether they are paid from a pension scheme or a life insurance policy.
   
   
7. No special relief for business or farm assets in pensions
   If your pension holds assets like farmland or shares in an unlisted business, these will not receive the usual agricultural or business property relief under IHT. The pension itself will be treated as a taxable asset, without any special exemptions for the underlying assets.
   
   
8. Overseas pensions and QNUPS will also be affected
   For those with overseas pensions, like QNUPS or QROPS, the new rules will apply as well. Previously, these pensions were exempt from UK IHT, but now they’ll be treated the same as UK pensions. If you’re UK-domiciled or deemed domiciled when you pass away, the value of these pensions will be included in your estate for IHT purposes.
   
   
9. New digital IHT reporting system
   HMRC acknowledges these changes will make things more complicated, so they plan to roll out a new digital system for reporting and paying IHT on pensions before 2027. The goal is to make things easier for executors and beneficiaries by reducing paperwork and speeding up the process.

Considerations for Expats

These changes do not just affect UK-based pensions. If you have overseas pensions, such as QNUPS or QROPS, you should pay attention to the changes.. Previously, these types of pensions were exempt from UK IHT, but now they will be treated the same as UK pensions. If you are UK-domiciled, the value of these pensions will be included in your estate for IHT purposes.

If you are non-domiciled, the rules are more complex. If you have been in the UK for 15+ years, you will be deemed domiciled for IHT purposes, and your overseas pensions will fall under the new rules. If you plan to retire abroad and maintain your non-domiciled status, you may still be able to keep your overseas pensions outside UK IHT, but this depends on your specific situation and your domicile status.

What Should You Do Now?

While the policy is still a developing situation, there  are some important steps you can take to  protect yourself:

Review your estate plan: If you’ve been planning to leave a significant pension fund to your loved ones, it’s worth revisiting your estate plan. Pensions that were once exempt from IHT may now push your estate above the tax-free threshold, potentially leading to a higher IHT bill. It’s a good idea to start assessing the possible impact and adjust your plans if needed.

Use or reallocate pension wealth: Since pensions will no longer be exempt from IHT, you might want to consider accessing your pension earlier, if it suits your circumstances. This could help lower the value of your estate and reduce IHT exposure.

Update your will and nomination forms: Take a moment to ensure that your will and pension beneficiary nominations are up to date. Executors will need to know about your pension arrangements to manage IHT properly when the time comes.

Prepare for the IHT bill: It’s important to plan for how your estate will cover any IHT on your pensions. If your estate consists largely of illiquid assets, your beneficiaries may face challenges in settling the tax. You might want to think about setting aside a cash reserve or exploring life insurance to help cover the bill.

Seek advice on international pensions: If you have pensions overseas or live abroad, now might be the right time to speak with a cross-border tax adviser. The rules for international pensions have evolved singinfcantly in recent years, and it’s important to ensure your plans are still right for you.

Time to Rethink Your Pension Strategy? Act Now to Protect Your Legacy

The extension of inheritance tax to pensions is a major shift in policy. If you’ve been using your pension with a view to pass wealth to the next generation tax-free, it’s time to rethink your strategy. While the changes may increase the tax burden for some, there are still ways to plan ahead and protect your legacy. The key is acting now, so you’re not caught off guard.

If you’re unsure how this might affect you, get in touch. It’s never too early to start reviewing your plans.