Changes to the treatment of Pensions for Inheritance Tax purposes

Pensions have, for many years, sat outside the scope of inheritance tax and you may not have given much thought to the taxation of your pension benefits on death when discussing inheritance tax mitigation with your advisors. This treatment will change from 6^th April 2027 when the value of any pension benefits payable on your death will be included when calculating your estate’s liability to inheritance tax. As with all estate planning the devil is in the detail and you should seek advice before making any decisions.

Currently most pension death benefits are subject to income tax treatment so that if you die before the age of 75 and if those benefits are taken within 2 years of your death, your beneficiaries will inherit the whole of your pension pot tax-free. If you die after the age of 75, your pension pot will be subject to income tax in the hands of your chosen beneficiaries. If you die after the 6^th April 2027 the income tax treatment will remain the same but there may also be a charge to inheritance tax which will be deducted at a rate of 40% from the gross benefit with income tax being applied on the balance. In some cases, this could result in your pension death benefit being subject to ‘double taxation’ as shown in the example below:

Bob, aged 77, dies leaving no estate but a pension fund of £1million which is to be paid to his son, Charles. He has no Nil Rate Band having made a gift of   £325,000  to Charles a year before he died. Charles is a higher rate tax payer

The tax calculation is as follows:

This results in a marginal rate of tax of 64%. In a worse-case scenario, the death benefit could result in the beneficiary losing their income tax personal allowance and, if the inclusion of the pension fund results in the estate as a whole exceeding the Residence Nil Rate Band threshold, the marginal rate of  tax will be even higher.

Those clients who leave their pension benefits to different beneficiaries to those who benefit under the terms of their Will may need to carefully consider how the tax on either portion will be funded and, if the objective is to achieve equality or fairness between those beneficiaries, the deduction of inheritance tax and income tax will need to be factored into any calculation to ensure this objective can still be met.  For example:

Derek dies in June 2027 aged 80 leaving an estate worth £500,000 and death pension benefits of £500,000. He had made no gifts in the last 7 years so that his inheritance tax threshold of £325,000 is available to his estate. His will leaves his estate to his daughter Elizabeth and his pension to his niece Fiona. His intention was that they should broadly receive a similar net sum but this will no longer be achieved under the new rules:

Now may be the time to consider how the impact of these changes can be mitigated to ensure your estate objectives are still met. There are ways to mitigate the tax liability to both your estate and your pension death benefit, including using the 25% tax-free element, making gifts of surplus income and/or capital and using life policies to fund any tax that cannot be reduced. It remains the case that your pension will not pass under the terms of your will and it is  still important to ensure that your pension nominations remain up to date and that you have reviewed your Wills in light of these changes.

Pensions are a complex financial investment and specialist financial advice will need to be taken alongside the legal advice we offer to ensure you leave the maximum value of your assets to your beneficiaries rather than HMRC. Please contact our Private Client team to arrange an appointment to review your affairs.

For further information, please contact Dawn Sullivan.

05/11/2026