What the new UK pension inheritance rules could mean for you
Most workplace pensions will face inheritance tax from 2027, so older people should think about their options.
How will the new rules work?
Right now, pensions are usually not counted as part of a person’s estate when working out inheritance tax (IHT). But last autumn, Rachel Reeves said that from April 2027, money left in a defined contribution pension after death will be included when calculating IHT.
Most workplace pensions and all private pensions are defined contribution pensions.
This means that any unused pension savings could be taxed as part of a person’s estate if the total amount is over the IHT limit.
Unused funds are money left in a pension that hasn’t been used yet, for example, money not used to buy an annuity (a type of retirement income), explains The People’s Pension provider.
Inheritance tax is a tax on a person’s assets after they die, if what they leave behind is worth more than a certain amount. The usual IHT rate is 40%. It only applies to the value above the tax-free limit, which is £325,000. (There is a separate limit for property.)
The rule allowing spouses or civil partners to inherit without paying Inheritance Tax (IHT) will stay the same. So, you can still leave everything to them without any tax. But other people who inherit might have to pay tax.
However, the exact details of how this will all work have not been decided yet.
How many people will be affected?
The government says most people will not be affected.
At the end of last year, the government estimated that out of about 213,000 estates with pension wealth in 2027-28, around 10,500 (just under 5%) would have to pay IHT for the first time because of these changes. Also, about 38,500 estates would end up paying more IHT than before. But the government added that these numbers might change, depending on how people react—for example, if they take money from their pensions more quickly.
The pension company Royal London says:
“If you own your home, and when you add your defined contribution pension to it, the total might be more than the amount you can pass on without paying Inheritance Tax (IHT). This could mean that IHT has to be paid when you or your husband or wife dies.”
What can you do now?
For older people who can afford it, the simplest option might be to spend more of their pension money now. But everyone’s situation is different, and it’s important to make sure you have enough money for the later years of your life.
Anick Sharma, a financial planner at Videre Financial Planning, says:
“Many older people are thinking about spending more of their pension while they’re alive because they don’t want their money to be heavily taxed after they die. The idea is simple – why leave behind money that will lose value because of tax when you could enjoy it now?”
He also points out that, by the time the estate (everything you own) is passed down, the children are often already financially stable and may not really need the inheritance.
Some parents are choosing to give their children money now to help them with things like buying their first home.
One way to access your pension is by buying an annuity. An annuity gives you a guaranteed income during retirement. So, in the future, more people might choose annuities.
Also, more older people may use equity release mortgages to deal with future IHT bills. This option is for people over 55 who want to take cash out of their property without having to move. Doing this lowers the value of your estate, which can reduce the IHT bill.
Andrew Oxlade, an investment director at Fidelity International, thinks some people might even sell their bigger homes and move to smaller ones. This could free up money, some of which could be given to children or grandchildren. The seven-year rule is important here (more on that below). With today’s young people finding it hard to buy a home, this might be something many parents consider.
There are different tax-free gift allowances available:
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You can give away up to £3,000 per year without it being added to your estate. You can give this to one person or split it among several people.
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The small gift allowance lets you give as many gifts of up to £250 per person as you like each year, as long as you haven’t used another allowance for that same person.
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You can also give tax-free gifts to people getting married.
Additionally, the “potentially exempt transfer” rule allows you to give money or gifts of any value to anyone. These gifts won’t be taxed if you live for seven years after giving them. However, there are rumours this rule might change to 10 years in the future.
Another option, says Cook, is to give gifts regularly from your normal income. As long as the money comes from regular income (like your pension or job) and it doesn’t reduce your standard of living, you can give away as much as you like, explains Alice Haine, a personal finance expert at Bestinvest.
Here’s an example of how the new rules might work:
Emily was 73 years old when she died. She had a defined contribution pension worth £700,000 and other assets worth £800,000. She didn’t have a spouse or civil partner. During her retirement, she didn’t use her pension because she lived off her other savings and assets. After she passed away, the pension money would go to the people chosen by the pension scheme.
Right now, for inheritance tax (IHT), only her £800,000 in other assets are counted. Her pension is not included. After using the £325,000 tax-free allowance, the tax bill would be £190,000 (which is 40% of the remaining £475,000).
But starting in April 2027, her pension will be included in the total estate value. This means her estate would now be worth £1.5 million (£800,000 + £700,000 pension). The IHT bill would rise to £470,000 (40% of £1.175 million after the tax-free allowance). Out of this £470,000 tax bill, £219,333 would be taken directly from the pension money before her beneficiaries receive it.
Published: 24th March 2025
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