Pensions and Inheritance Tax - What’s Changing and What You Can Do About It

In Autumn 2024, Labour announced in their budget that from April 2027, most unused pensions will start being treated differently when someone dies. After a lengthy consultation, the Government recently released the new rules confirming that, in many cases, they’ll be included in the value of your estate for inheritance tax purposes.

While the government estimates that around 8% of estates will be affected, that figure only tells part of the story. As ever, the finer detail matters. Many families could still feel the impact - not just from the tax itself, but from decisions people make now about how they draw their pensions and plan their legacies.

What’s actually changing?

From April 2027, most defined contribution pensions (including SIPPs and personal pensions) left unused when someone dies will be counted as part of their estate. This could mean inheritance tax (IHT) is due, depending on the size of the overall estate and who’s inheriting it.

Some pensions are unaffected, including:

  • Dependants’ pensions from defined benefit (e.g. final salary) schemes

  • Survivors' pensions from annuities

  • Death in service lump sums tied to pension schemes if the person who died was still working.

  • Eligible lump sums paid to registered charities

The usual IHT rules still apply

These changes don’t remove the usual allowances and exemptions:

  • The spousal exemption means anything left to a husband, wife or civil partner is free from IHT.

  • Everyone gets a £325,000 nil-rate band, and if you own a property that passes to a direct descendent, there’s a further £175,000 residence nil-rate band available (tapered for estates over £2m).

  • Together, a married couple can often pass on up to £1 million without paying IHT.

But these new rules could still mean families paying significant tax on pensions that have long been outside the IHT net, especially for those over 75 or with larger pension pots.

Who pays the tax?

Inheritance tax on pensions will initially be the responsibility of the estate’s executors or personal representatives. However, pension beneficiaries (if different from those inheriting the rest of the estate) can request that the pension provider pays the tax directly, if certain conditions are met and the tax bill exceeds £4,000.

What about income tax?

Remember that if someone dies aged 75 or older, their beneficiaries already pay income tax on anything they withdraw from an inherited pension. This doesn’t change, but it does mean that some beneficiaries could face both inheritance tax and income tax on the same pension. That’s a substantial combined tax burden to consider.

What should I do now?

Although the changes don’t take effect until April 2027, it’s wise to review your arrangements well in advance. A few key things to think about:

  • Think about when and how to access your pension – some people may now take more from their pensions during their lifetime, or rethink the order they draw from ISAs, pensions, and other assets.

  • Review your pension nominations – just as you would your will. Who inherits what, and does it still reflect your wishes? Have you considered the tax implications?

  • Consider your spouse or civil partner’s position – the spousal exemption still offers protection from IHT, so it may make sense to switch your nominations closer to 2027.

  • Use gifts to reduce IHT exposure – taking income from your pension and gifting it (especially if done regularly and from surplus income) could reduce the chance of tax later on.

For those already over 75, it may be particularly important to review any unused tax-free cash. If you pass away after 75 without taking it, this cash may no longer be tax-free.

At Harold Stephens, we’ve already been helping many of our clients and their families navigate the implications of these rule changes, and understand how best to adapt their plans. If you’ve been waiting for confirmation before seeking advice, now is the time to act.

We’re here to help you make informed, confident decisions about your legacy. Book a complimentary financial or inheritance tax review with one of our later life planning specialists – and start taking control of what happens next.

Call 0117 3636 212 or email office@haroldstephens.co.uk.

Below is Richard Higgs’ overview of all of the changes that Labour proposed with some ideas for financial planning around the new rules.

Amy Wood