Changes to Inheritance Tax on Pension Pots from Spring 2027
Elderly individuals rapidly accessing inherited funds to dodge Rachel Reeves's inheritance tax increase plan
From 6 April 2027, the UK government will introduce significant changes to the way pension pots are treated for inheritance tax (IHT) purposes. Currently, defined contribution pensions are typically exempt from IHT, allowing beneficiaries to inherit unused funds tax-free, especially if the pension holder dies before age 75. However, under the new rules, these pension funds will be included in the estate for IHT calculations, potentially leading to a 40% tax charge on any value above the nil-rate band [1][3].
Impact on Higher Rate Taxpayers
Higher rate taxpayers or those with larger estates may be particularly affected by these changes. Since the new rules treat pension pots similarly to other assets, estates with significant pension wealth will be more likely to exceed the IHT threshold, triggering the 40% tax rate. This could result in beneficiaries receiving less inheritance, as more of the estate will go towards paying IHT [1][2].
The government aims to increase tax revenue and reduce perceived loopholes that allow wealthy individuals to pass on assets tax-free through pension schemes [1]. However, many view this change as penalizing those who have diligently saved for retirement under the existing rules [1].
Key Points
- 40% Tax Rate: Estates exceeding the IHT threshold will be subject to a 40% tax on pension assets.
- Inclusion in Estate: Pension funds will be treated like other assets for IHT purposes.
- Impact on Beneficiaries: Inheritance received by beneficiaries may decrease due to increased IHT liability.
- Financial Planning: Existing retirement plans may need to be revised to account for these changes.
Strategies for Higher Rate Taxpayers
Higher rate taxpayers might consider revising their financial plans to mitigate the impact of these changes. This could involve drawing down pension funds more quickly or using other tax-efficient strategies to minimize the IHT burden. Additionally, reviewing estate planning to ensure that assets are distributed in the most tax-efficient manner will be crucial [3][5].
The number of people making taxable pension withdrawals increased by 13% to 672,000 in 2025 compared to 2024 [6]. Adrian Murphy, chief executive of Murphy Wealth, suggests that the figures may plateau or decline in the next set of figures due to the government's decision to include pensions in inheritance tax [4].
Pension withdrawals increased by almost a quarter to £5 billion in the first three months of 2025 [6]. Claire Trott, head of advice at St. James's Place, expresses concern about the slight decline in the number of individuals contributing to their pensions [7]. She suggests that constant speculation and changes to pension tax rules are damaging and can impact savers' views of pensions as long-term, stable savings vehicles.
The Government wants pensions to be used for retirement, not for transferring wealth. For higher rate taxpayers, the total tax on pension pots can be as high as 64% (40% death duties and 40% income tax on withdrawals) [2]. Those who die after the age of 75 will see their pension pots subject to both inheritance tax and income tax levied on beneficiaries.
Inheritance tax is levied at 40% on estates above a certain size. The residence nil rate band starts being removed once an estate reaches £2 million, at a rate of £1 for every £2 above the threshold. It vanishes completely by £2.3 million [5]. Claire Trott also emphasizes the importance of maintaining the current tax reliefs and allowances to ensure more individuals have adequate savings for their future.
The amount contributed to pensions in 2023-24 showed a 13% annual rise to £14.6 billion [8]. Chancellor Rachel Reeves announced in the Budget that these thresholds will be frozen until 2030 [9]. However, the residence nil rate band increases the threshold by £175,000 each for those who leave their home to direct descendants, creating a potential maximum joint inheritance tax-free total of £1 million [5].
[1] - https://www.gov.uk/government/publications/inheritance-tax-changes-to-pension-death-benefits/changes-to-pension-death-benefits-from-6-april-2027 [2] - https://www.ftadviser.com/pensions/2023/03/21/pension-tax-changes-to-hit-retirees-hardest-report-finds/ [3] - https://www.ftadviser.com/pensions/2023/03/16/pension-tax-changes-could-encourage-more-to-drawdown/ [4] - https://www.ft.com/content/844bfc6e-3899-4d0e-8a89-e76197b8980e [5] - https://www.gov.uk/guidance/inheritance-tax-planning-and-the-residence-nil-rate-band [6] - https://www.ft.com/content/227c8e6a-8644-4b91-a20c-3412463e7715 [7] - https://www.ft.com/content/f41f5c6f-127d-46a5-874a-9026638a0440 [8] - https://www.gov.uk/government/publications/annual-pension-statistics-2023/annual-pension-statistics-2023 [9] - https://www.gov.uk/government/news/chancellor-announces-freeze-on-inheritance-tax-nil-rate-band-and-residence-nil-rate-band-until-2030
- Higher personal-finance Management is crucial for those affected by the changes in inheritance tax on pension pots, as they may need to revise their financial plans and consider drawing down pension funds more quickly.
- With significant changes coming to the treatment of pension pots for inheritance tax purposes in 2027, there is a potential for those with larger estates to have a 40% tax charge on any pension value above the nil-rate band, impacting their savings and the inheritance received by their beneficiaries.
- In light of these changes, it's essential for individuals to review their estate planning to ensure assets are distributed in the most tax-efficient manner, such as taking advantage of the residence nil rate band if they leave their home to direct descendants.
- The impact of the tax changes on pensions could beénying the perception of pensions as a reliable and long-term savings option, as some view the constant speculation and modifications to pension tax rules as damaging.
