After an extended period of consultation the government has finally issued draft legislation and confirmed that from April 2027 “unused pension funds” will form part of an estate for inheritance tax purposes.
In this article FPC Senior Adviser, Paul Welsh, considers:
Please note this is still draft legislation and whilst we do not anticipate significant amendments there is still potential for fine-tuning, so please do not take action without personal advice as there is no one size fits all.
In October 2024, Chancellor Rachel Reeves announced a significant change to the UK’s inheritance tax (IHT) rules proposing that from 6 April 2027, unused pension savings and death benefits would no longer be exempt from IHT and would be treated as part of the deceased’s estate.
These changes coincided with the announcement that from April 2026 business and agricultural assets in excess of a combined individual lifetime IHT allowance of £1m would also become subject to IHT delivering a double blow to many FPC clients.
In the case of the pensions change, the rationale was that this would prevent pension schemes from being used as a tax planning vehicle to transfer wealth, rather than as a means of funding retirement.
The reality of course is that these measures come against a backdrop of a government with serious funding challenges as a result of the current deficit of £16.3 billion in June 2025.
The HMRC impact report suggest that only 10,500 estates will be brought into IHT and approximately 38,500 estates will pay more IHT than would previously have been the case. The measure will result in potential revenue of just £640m in 27/28, rising to £1.46bn in 2029/30, so will have limited fiscal impact but will have a huge financial impact on our clients estate planning. Source: HMRC impact
Under current rules, in the event of death after age 75 any pension benefit paid to a beneficiary is subject to income tax at their marginal rate.
These changes mean that once IHT is factored it results in a potential effective tax rate of 52% for a basic rate taxpayer rising to 67% for a top rate taxpayer.
It could however have been even worse if an individual had to withdraw funds from a pension, pay income tax first, and then IHT but that additional burden is thankfully not being applied. Source: HMRC explanatory note
Personal representatives will be responsible for payment of tax.
In a welcome change to what was originally proposed, it is now the personal representatives of the deceased who will be responsible for reporting and paying any IHT rather than the pensions scheme administrator (PSA).
The original proposal would have had the PSA having to assess the overall asset position of the estate and agree how any IHT allowances were apportioned between the estate, themselves and any other pensions schemes.
This would have led to significant delays in dealing with estates and paying out death benefits and could impact many estates that are not even be subject to IHT, inflicting untold stress, cost and complexity on bereaved individuals and families.
There are however still real challenges as the draft legislations states that:
In reality – trying to value pension scheme assets within four weeks where that pension scheme might hold commercial property is not practical as professional valuations are likely to be required which will take time and incur costs.
Similarly, paying IHT within three weeks of a request may be impossible if there is no readily available liquidity within the scheme.
SSAS’s in particular, where there are typically pooled funds and multiple members, may find their positions compromised by having to raise finance to pay IHT.
Estates in general have 6 months from date of death (not long already in the light of probate timescales) to pay IHT before interest accrues so we can only hope a more pragmatic approach emerges here.
Death in service benefits exempt from IHT
Good news here as HMRC has confirmed that death in services schemes regardless of how they are provided will not be subject to IHT.
However questions remain as to whether the level of any death in service benefits will still be subject to restrictions.
This is practically important as death in service benefits are often the only life cover many employees actually have and to bring them into the IHT regime would have been a cruel blow to many bereaved families.
It is also perhaps politically expedient as it means that all public sector workers will have their death in service benefits protected.
This measure gives scope for Company Directors to review their own insurance provision.
The main attractions of pensions funding have always been tax relief on contributions, tax free growth, and tax free cash on retirement. They also serve as a means of potentially deferring tax on income until a lower income tax rate might be applicable.
Those benefits all still remain and pensions still serve as a valuable tool for retirement planning.
For many individuals, with estates below the £325,000 nil-rate band allowance (or £500,000 with the residence band), these changes may have minimal immediate impact but there is a concern that this measure may turn some away from utilising pensions allowances.
For high-net-worth clients, pensions and estate planning have gone hand in hand for many years. Our view is that position has not changed but there are now additional considerations including:
All eyes are on the 2025 Autumn Budget, as the Chancellor has a black hole to fill that can only be addressed by further tax rises.
Having backtracked on a number of costly measures recently and with a pledge to only raise debt for investment she has left herself with little room for manoeuvre.
There are major doubts about Labour’s ability to honour their manifesto pledge not to increase direct taxes (already blown somewhat by the rise in National Insurance) and as a result, the extension of a freeze on, or even a reduction in, relief’s and allowances may be on the cards although none of that will have as significant an impact as an increase to a major revenue source such as VAT.
We are gearing up for an acceleration of pensions and ISA funding in advance of the Budget and will be addressing that issue with clients directly.
While pensions retain their benefits—for retirement income and tax-efficient savings—their role as an estate planning vehicles has shifted.
We will continue to take a holistic approach viewing pensions and other tax efficient options such as ISA’s and investment bonds as part of the financial planners tool kit.
All clients will need to re-assess their pension funding and drawdown strategies in the run up to 2027 and beyond and we remain focused on helping our clients continue to meet both their retirement and legacy goals, despite a changing tax landscape.