Your Pension and what might happen.
From 6 April 2027, unused pension funds and most lump sum death benefits will be included in your estate for Inheritance Tax (IHT) purposes
This is a major shift because:
- Currently: Pension funds are usually outside your estate, so no IHT is due.
- From 2027: Pension funds will be inside your estate, and subject to 40% IHT if your estate exceeds the nil-rate band (£325,000 per person or up to £1 million for a couple including the residence nil-rate band).
Why Wait to Take Lump Sums?
If you take taxable lump sums now, and then die before 2027, your estate could face double taxation:
- Income Tax on the lump sum when you take it.
- Inheritance Tax on the remaining funds if you die after 6 April 2027.
Example: Double Taxation Risk
Let’s say James has a £1 million pension pot, is aged 76, and takes a £100,000 lump sum in 2026.
- He pays Income Tax on the lump sum (say 40% as a higher-rate taxpayer):
£100,000 × 40% = £40,000 tax, leaving £60,000. - James dies in 2028, and the remaining £900,000 is now part of his estate.
- His estate exceeds the IHT threshold, so 40% IHT applies to the pension:
£900,000 × 40% = £360,000 tax. - Total tax paid:
£40,000 (Income Tax) + £360,000 (IHT) = £400,000. - Effective tax rate on the original £1 million: 40%.
But if the beneficiary is also taxed on withdrawals, the effective rate could reach 67–90%.
What If You Have a Spouse?
Good news: Transfers to a spouse or civil partner remain IHT-free, even after 2027
So if James leaves his pension to his wife:
- No IHT is due.
- She can continue to draw income from the pension.
- But if she dies later and leaves the remaining pension to children, IHT will apply unless further planning is done.
Over Age 75: Income Tax Still Applies
If you die after age 75, your beneficiaries pay Income Tax on pension withdrawals at their own rate (e.g., 20%, 40%, or 45%)—even before 2027
From 2027, they may also face IHT on the inherited pension, unless they’re your spouse or a charity.
Planning Tips
- Delay lump sum withdrawals unless needed for living expenses.
- Spend other assets first (e.g., ISAs, savings) to preserve pension tax efficiency.
- Review nominations to ensure your spouse is the primary beneficiary.
- Consider annuities or gifting strategies to reduce estate value.
- Use life insurance in trust to cover future IHT liabilities.
Summary
| Scenario | Tax Impact Before 2027 | Tax Impact After 2027 |
|---|---|---|
| Pension left to spouse | No IHT | Still no IHT |
| Pension left to children | No IHT if No income tax if under 75 or Income tax if over 75 | 40% IHT No income tax if under 75 or Income tax if over 75 |
| Lump sum taken now, death after 2027 | Income Tax now + IHT later | Double taxation risk |
Key IHT Exemptions & Planning Opportunities
1. Annual Gift Exemption
- You can gift £3,000 per year tax-free.
- If unused, you can carry forward the previous year’s allowance once, allowing £6,000 in a single year.
- Can be split among multiple recipients.
2. Small Gifts
- You can give £250 per person per year to any number of people, as long as they don’t also receive part of your £3,000 exemption.
3. Wedding Gifts
- Tax-free limits based on relationship:
- £5,000 to a child
- £2,500 to a grandchild or great-grandchild
- £1,000 to anyone else
4. Gifts for Maintenance
- Tax-free if for:
- Children under 18 (education/training)
- Elderly or infirm relatives
- Ex-spouses or civil partners
5. Charitable Donations
- Gifts to UK charities are IHT-free.
- If you leave 10% or more of your estate to charity, the IHT rate on the rest drops from 40% to 36%.
💡 Powerful Strategy: Gifts from Surplus Income
What Is It?
Gifts made regularly from your income (not capital) that don’t affect your standard of living are immediately exempt from IHT—no 7-year rule applies
Conditions:
- From income (salary, pension, dividends, rental income—not capital).
- Regular and habitual (e.g., monthly or annual payments).
- Doesn’t reduce your lifestyle.
Example:
James gifts £500/month from his pension to his daughter:
- Total: £6,000/year.
- If documented properly, this is fully exempt from IHT—even if James dies within 7 years.
Tips:
- Keep records of income and gifts.
- Write a letter of intent stating the gifts are from surplus income.
- Avoid gifting assets you still benefit from (e.g., living in a gifted house)—this is a gift with reservation and still taxable.
🧠 Strategic Planning Ideas
- Use pension income for regular gifts to children or grandchildren.
- Combine exemptions: e.g., £3,000 annual + £250 small gift + surplus income.
- Gift early: The 7-year rule means gifts made earlier are more likely to be IHT-free.
- Consider trusts: But get advice—some trusts trigger immediate IHT charges.
- Review estate regularly: Especially with the 2027 pension inclusion rule.
Sources
Inheritance Tax on unused pension funds and death benefits – GOV.UK
How Inheritance Tax works: thresholds, rules and allowances: Rules on giving gifts – GOV.UK
⚠️ Disclaimer
Tax rules and FCA regulations are subject to change. The information provided reflects current legislation and proposed changes as of August 2025, including the inclusion of unused pension funds in estates from 6 April 2027. This does not constitute financial advice. Clients should seek personalised guidance from a regulated financial adviser before making decisions regarding pension withdrawals, estate planning, or gifting strategies.