Pensions and Inheritance Tax - planning for the April 2027 changes

Pensions have long played an important role in estate planning. Unlike most other assets, pension funds have generally fallen outside the scope of inheritance tax (IHT) because death benefits are typically paid at the discretion of pension scheme trustees rather than forming part of the deceased’s estate.

However, this position is set to change. Following the Autumn Budget 2024, the Government announced that most unused pension funds and pension death benefits will be brought within the scope of inheritance tax from 6 April 2027. This represents a significant shift in how pension wealth will be treated on death and could alter the way many individuals structure their estate planning.

Pensions have traditionally been viewed as an efficient way to pass wealth to the next generation because they typically sit outside the estate for inheritance tax purposes. From April 2027, that position will change. Individuals with substantial pension savings may therefore wish to review their estate planning to ensure it still achieves their intended outcomes.

Below outlines some of the key issues to consider.

Pensions entering the inheritance tax net

From 6 April 2027, most unused pension funds and pension death benefits will be included when calculating the value of an individual’s estate for inheritance tax purposes.

Under the current framework, pension scheme trustees typically retain discretion over the distribution of death benefits, which has meant that pension funds usually fall outside the estate for tax purposes.

The proposed reforms will change this position. In many cases, the value of unused pension savings will be taken into account when calculating the overall value of the estate.

Where the estate exceeds the available inheritance tax thresholds, this could result in tax being charged at up to 40 per cent on the excess value of the estate including the value of the unused pension.

Which pensions are affected?

The reforms are expected to apply broadly across most registered pension schemes, including:

• personal pensions;
• workplace defined contribution schemes;
• self-invested personal pensions (SIPPs); and
• small self-administered schemes (SSAS).

For many individuals, pensions represent one of their most valuable assets, particularly where savings have accumulated over many years.

However, the Government has confirmed that death-in-service benefits payable to family members from a registered pension scheme will remain outside the scope of inheritance tax.

Additional complexity for SIPPs and SSAS arrangements

The proposed changes may be particularly significant where pension arrangements hold substantial underlying assets.

SIPPs and SSAS pensions are sometimes used to generate retirement income by holding assets such as:

• commercial property;
• private company shares; or
• other long-term investments.

Where these assets have increased significantly in value, bringing them within the inheritance tax calculation could increase both the tax exposure and the complexity of estate administration.

Implications for executors and estate administration

The reforms will also have practical consequences for estate administration.

From April 2027, personal representatives will be responsible for reporting and paying any inheritance tax due on unused pension funds and pension death benefits.

Executors may therefore need to liaise closely with pension scheme administrators to establish the value of pension benefits and ensure that the appropriate tax is accounted for during the administration of the estate.

In some cases, personal representatives may direct pension providers to withhold part of the death benefits to meet the inheritance tax liability before distributing the remaining funds to beneficiaries.

Interaction with income tax

Pension death benefits may also be subject to income tax depending on the age of the pension holder at the time of death.

Under the current rules:

• if death occurs before age 75, beneficiaries can generally receive pension benefits free of income tax; or
• if death occurs after age 75, withdrawals are typically taxed at the beneficiary’s marginal income tax rate.

The introduction of inheritance tax on pension funds from 2027 means that, in some circumstances, pension wealth could be exposed to both inheritance tax and income tax, depending on how benefits are structured and withdrawn.

Death benefits and nominations

Despite the proposed changes, pension nomination forms - often referred to as an ‘expression of wishes form’ - will remain an important part of pension planning.

These forms allow pension holders to indicate who they would like to receive their pension death benefits. While they are not legally binding, pension scheme trustees will typically take them into account when deciding how benefits should be distributed.

Keeping nomination forms up to date remains essential, particularly where personal circumstances have changed through marriage, divorce or the birth of children.

It is also important to ensure that pension nominations align with your will and wider estate planning arrangements.

Three steps to consider before April 2027

Although the reforms will not take effect until 6 April 2027, individuals with significant pension savings may wish to begin reviewing their arrangements now. In particular, three areas are worth considering.

• Review your pension nomination forms - ensuring that nominations are up to date can help pension trustees understand who you intend to benefit and how benefits should be distributed.
• Consider how pensions fit within your overall estate - For many people, pensions represent one of their largest assets. If these funds are brought within the scope of inheritance tax, it may be sensible to review how pension savings sit alongside other assets such as property, investments and business interests.
• Seek coordinated legal and financial advice - Decisions about drawing pension income, restructuring investments or making lifetime gifts can have complex tax consequences. Taking advice from both legal and financial advisers can help ensure that any changes support your long-term succession and tax planning objectives.

How we can help

Our private client team regularly advises individuals and families on inheritance tax, estate planning and the interaction between pensions and succession planning.

We can assist by:

• reviewing the potential impact of the 2027 pension inheritance tax changes on your estate;
• advising on wills and succession planning where pensions form a significant part of your wealth;
• working alongside financial advisers to ensure coordinated planning; and
• helping ensure your arrangements remain appropriate as tax rules evolve.

For advice on estate planning or inheritance tax, please contact a Legal Adviser in our Private Client team at York, Selby, Malton or Pickering.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.