Pensions and Inheritance Tax: What the New Rules Mean for You

In Labour’s first Budget of 2024, Chancellor Rachel Reeves announced a significant shift in

pension legislation. Subject to the Finance Bill being ratified, these proposals have now been

confirmed and, from April 2027, inherited pension funds will become subject to Inheritance

Tax (IHT). This represents a major change from the long-standing position where pensions

have generally fallen outside the scope of IHT.

The Current Position

Under existing rules, pension funds that have not been used to purchase an annuity can be

passed to a spouse or nominated beneficiary on death. The tax treatment depends on the

age at death: Where death occurs before age 75, beneficiaries can usually withdraw inherited pension funds free of Income Tax; where death occurs after age 75, withdrawals are subject to Income Tax at the beneficiary’s marginal rate.

Importantly, pension funds are not normally included within the deceased’s estate for IHT

purposes. This has made pensions an effective tool for both retirement planning and

intergenerational wealth transfer.

What Is Changing from 2027

From April 2027, any unspent pension assets on death will be included within the estate for

IHT calculations.

The impact will depend on the total value of the estate.

If the estate exceeds £325,000 (or £500,000 where a home worth at least £175,000 is left to

a direct descendant and the total estate is below £2 million), pension funds above these

thresholds may be subject to IHT at 40 percent.

Where death occurs after age 75, beneficiaries may face both Income Tax and IHT on the

same pension funds.

This combination could result in an effective tax rate of 52 percent for a basic rate taxpayer

or 64 percent for a higher rate taxpayer on pension assets that exceed the available IHT

allowances.

Additional Budget Announcements

In the most recent Budget, Reeves confirmed further pension-related measures, including

plans to charge National Insurance on salary sacrifice pension contributions above £2,000.

What Is Not Changing

Several widely anticipated changes did not materialise. Key features of the current system

remain in place. Up to 25 percent tax free cash can still be taken from your pension, subject to protections; Pension funds will continue to grow free of Capital Gains Tax and Income Tax; Pension contributions made within the rules will continue to attract tax relief at your marginal rate; The state pension triple lock remains in place; The spousal exemption continues, meaning funds left to a surviving spouse or civil partner remain free of IHT on first death.

The Less Positive News

Reeves also confirmed in the Autumn Budget 2025 that the £325,000 IHT nil rate band will

remain frozen until April 2031. This threshold has been unchanged since 2009 to 2010.

Where a family home is passed to children or grandchildren, the Residence Nil Rate Band

(RNRB) may provide an additional £175,000 allowance. However, this allowance tapers once the estate exceeds £2 million, reducing by £1 for every £2 above this level.

With pensions now forming part of the estate for IHT purposes, and with rising property and

asset values, many more families are expected to exceed these thresholds and face

significant IHT liabilities.

Planning Ahead

These changes highlight the importance of proactive planning and regular review. With the

new rules taking effect in 2027, there is still time to assess your position and adapt your

strategy.