Inheritance tax and pensions: how to cope with the new reality

Inheritance tax will be levied on unused pension funds after death from April 2027.

This change has major implications for people looking to leave money to their loved ones.

Here we take a look at how to cope with the new regime and maximise what you can leave your family.

What is inheritance tax?

With limited exceptions, inheritance tax (IHT) of 40% is charged on anything you leave after your death over £325,000. This amount is known as the ‘nil-rate band’.

If you leave your main home to your children or grandchildren, you may also get a residence nil-rate band of £175,000. This adds up to a maximum £500,000 before tax kicks in. Therefore a couple who are married or in a civil partnership can potentially pass on up to £1m without their inheritors paying tax.

While this may not sound too bad at first, when you look a little closer then alarm bells may well start to ring.

For example, as of March 2025, the average UK house price was £271,000, a 6.4% increase on the same month in 2024. In 15 years at that annual growth rate, your house would be worth over £531,000.

But with annual house price growth over the last 10 years estimated at 12.1% (by estate agency Zoopla), then after 15 years your home could actually be worth more than £762,000.

With the nil-rate band frozen until 5th April 2030 and higher house prices in certain parts of the country, people even on fairly modest means are now falling into the IHT trap.

Why isn’t my pension safe from tax after my death?

At the moment, defined contribution pensions – those where you build up a pot of money to give you an income when you retire – don’t form part of your estate when you die. Consequently, your family doesn’t currently have to pay inheritance tax on any unused defined contribution pensions after your death.

However, from April 2027, any unused defined contribution pensions will be treated as part of your estate for IHT purposes.

What does this change mean?

Including pension funds in IHT calculations could mean that your estate surpasses the IHT threshold. The rise in house prices and the freeze on tax thresholds makes this even more likely.

Anything above the threshold will be liable for tax at a current rate of 40%. This could have significant financial consequences for your beneficiaries, especially with many people currently using their defined contribution pensions to help pass on assets to the next generation.

As well as potentially paying more in tax, bringing pensions under the IHT umbrella will also cause delays. With HMRC assessing pension funds as part of the overall estate, beneficiaries may face months of waiting for the probate process to be completed. This process could take even longer for more complex estates.

Pension scheme administrators will have to determine the value of any unused pension funds at the time of death and include these in the calculation for IHT. Again, this could lead to significant delays.

What can I do to cut down on delays?

With this major change less than two years away, you should take stock of your current situation and evaluate the total value of your assets.

Add up the current worth of your pensions, properties and investments to see where you stand. You should also check you have all appropriate documentation in place. Once you have a comprehensive picture of your financial position, you can start to look at ways of tax-efficient planning.

How can I maximise what I leave for my family?

Careful planning and expert help from a financial adviser can help you to preserve as much as possible of your estate. It can also avoid leaving your family facing major financial headaches.

Here are some options to consider for cutting down on potential inheritance tax liabilities:

Spending more

As a retiree after being careful with incomes and outgoings for many years, this can be easier said than done. However, it is one sure way of reducing your taxable estate.

Gifting money

You can give away up to £3,000 in any tax year without it counting towards IHT. You can also carry forward unused allowance from the previous year. As a result, you could gift up to £6,000 if you haven’t used it previously.

You can gift additional amounts for weddings and civil partnerships. This can be up to £5,000 to a child, up to £2,500 to a grandchild or great-grandchild and up to £1,000 for anyone else.

Also, you can gift up to £250 per person per tax year, if that person hasn’t received part of your £3,000 annual exemption.

Gifts above these amounts are called Potentially Exempt Transfers (PETs). If you live for seven years after giving the gift, it won’t be taxed. If you don’t, then IHT is charged on a sliding scale as follows:

Using Trusts

A Trust is a legal structure that lets you set aside assets for your loved ones while keeping some control over how and when they receive them.

Some trusts are taxed at lower rates or even avoid IHT entirely, depending on how they’re set up. For example:

• Bare trusts are simple and tax-effective for gifts to children
• Discretionary trusts offer flexibility but may have different tax rules

However, Trusts are complex. A financial adviser or an estate planning expert can ensure they are set up correctly and carry out your wishes.

Using life insurance

Many people assume that life insurance policies are only there to help families in the event of an untimely death.

However, you can take out a life insurance policy to cover the anticipated cost of an inheritance tax bill. These policies can be taken out at later stages in life.

If the policy is written in trust, then the payout doesn’t count as part of your estate and won’t be taxed. You should get professional advice since such policies do not come cheap and need careful handling to be effective.

Investing in businesses or agricultural relief

You could consider using some funds to make an investment that qualifies for Business or Agricultural Relief.

From April 2026, any assets worth up to £1m and which you have held for at least two years will get 100% relief from inheritance tax. Assets above that level will qualify for 50% relief from IHT, effectively taxing them at 20% rather than the standard 40%.

Qualifying quoted but unlisted shares (such as those on the Alternative Investment Market) will attract 50% relief from inheritance tax.

This is a complicated area so take expert investment advice and taxation advice before progressing with any plan.

Planning with your spouse or civil partner

If your defined benefit pension fund is left to your spouse or civil partner, they will not have to pay any inheritance tax.

Nonetheless, when they die, that pension could still attract IHT. The same principle applies when it comes to property.

A financial adviser or estate planning expert can help you put in place joint plans to help maximise benefits.

For example, a joint lives second death policy in trust for the beneficiaries of your estate may help to cover the IHT bill.

Key takeaways

Inheritance Tax on pensions will make it harder for people to pass on assets without attracting increased tax bills. This especially the case when you consider rising house prices and frozen tax allowances.

Careful planning with financial and estate planning advisers can create useful solutions to ensure you maximise what you leave behind.

To find out more, why not get in touch with one of our experts by clicking the link below.

Disclaimer: This article is for informational purposes only and does not constitute financial, tax, or legal advice. Tax treatment depends on individual circumstances and may change. Always seek professional advice before making financial decisions.