If you’ve worked hard to build up a defined contribution pension, you probably expect to pass on that money tax-efficiently when the time comes. After all, pensions have long sat outside your estate for inheritance tax (IHT) purposes. But from 6th April 2027, that’s set to change.
Under new rules, pension pots could face not one, but two layers of tax, leaving less for your loved ones and more for HMRC. If retirement is on the horizon, now’s the time to take a closer look at how your pension fits into your estate plan.
In a Hurry? Here’s What You Need to Know
Pensions and inheritance tax:
Defined contribution pensions are currently excluded from your estate for inheritance tax (IHT). But from 6th April 2027, pension funds will count towards your taxable estate.
Two layers of tax:
If you die after 75, your pension could be hit by both inheritance tax (up to 40%) and income tax when accessed by your beneficiaries.
Who it affects:
Anyone with a defined contribution pension, especially those planning to leave their pot for inheritance purposes.
What you can do:
• Keep your beneficiary nominations up to date.
• Consider withdrawing from your pension strategically.
• Use gifts and trusts where appropriate.
• Make the most of inheritance tax allowances, including the residence nil-rate band (£175,000).
• Get tailored advice to align your pension and estate plan.
Next steps:
• Join our free IHT webinar in June to get expert guidance.
• Or speak to an adviser for personalised support.
Where Things Stand Today
If you have a defined contribution pension, it’s currently excluded from your estate for inheritance tax purposes. That means:
• Your pension isn’t counted when calculating how much inheritance tax liability is due.
• If you die before age 75, your beneficiaries can usually access the money tax-free.
• If you die after age 75, your beneficiaries pay income tax on withdrawals, but not inheritance tax.
This setup has made pensions a popular tool for passing on wealth, with many people using other savings first and preserving their pension to leave as a tax-efficient legacy.
What’s Changing from April 2027?
From 6th April 2027, any money left in your defined contribution pension will be included in your taxable estate for inheritance tax. That could trigger an unexpected tax bill and significantly reduce what your beneficiaries receive.
Here’s what you need to know:
• If your total estate (including your pension) exceeds the inheritance tax threshold of £325,000 (or £500,000 if you also qualify for the £175,000 residence nil-rate band) anything above that could be taxed at 40%.
• In terms of the residence nil-rate band the amount the estate is entitled to is reduced or “tapered away” for estates worth more than £2 million by £1 for every £2 over £2 million.
• If you die aged 75 or over, your beneficiaries will also pay income tax on what they withdraw from the pension.
• That’s potentially two layers of tax — leaving much less than you intended.
These changes don’t affect how you access your pension during your lifetime, but they do mean pensions may no longer be the inheritance tax shelter many people assume they are.
How To Protect Your Pension from Tax
The upcoming changes to pension inheritance rules don’t eliminate the benefits of pensions for estate planning, but they are a clear prompt to review your approach. Below are six key strategies to help you protect your pension’s tax efficiency and pass on more to your loved ones.
1. Check and Update Your Beneficiary Nominations
Pension death benefits aren’t automatically part of your Will. Instead, they’re typically distributed according to the nomination held by your pension provider. If this isn’t up to date (or worse, if no nomination is in place) your pension could be paid into your estate, triggering an inheritance tax charge unnecessarily.
What to Do:
• Contact your pension provider and request a nomination form if needed.
• Review your nomination regularly, especially after major life events like marriage, divorce or the birth of a child.
• Consider naming multiple beneficiaries to help spread tax liability and provide flexibility.
2. Draw from Your Pension Strategically
Leaving your pension untouched may no longer be the most tax-efficient route. From 6th April 2027, pension funds will form part of your taxable estate, so carefully planned withdrawals could reduce the inheritance tax burden.
What to Do:
• Work with an independent financial adviser to determine if partial drawdown makes sense for you.
• Consider using pension withdrawals to fund other tax-efficient investments, gifts, or trusts that fall outside your estate.
• Ensure any withdrawals won’t negatively affect your long-term income needs or push you into a higher income tax bracket.
3. Gift Withdrawn Funds During Your Lifetime
Once funds are withdrawn from a pension, they become part of your estate. But if you gift the money and survive seven years, it generally falls outside of your estate for inheritance tax purposes.
What to Do:
• Use your annual gift allowance (£3,000 per tax year) and small gift exemptions where possible.
• Consider larger gifts as part of a long-term strategy, particularly if you’re confident you won’t need the funds yourself.
• Document gifts clearly and keep records in case HMRC requires evidence later.
4. Use Trusts to Control and Protect Pension Wealth
Trusts such as spousal bypass trusts can help control how pension death benefits are used and may offer some inheritance tax protection — particularly if the rules evolve further in the future. However, trusts come with administrative complexity and may still be subject to inheritance tax under certain conditions. Additionally, individuals should be aware that while spousal bypass trusts can provide advantages, they may also impose restrictions on the beneficiaries’ access to funds. It’s crucial to consider the implications of inheritance tax on life insurance, as this could impact the overall estate planning strategy. Therefore, seeking expert advice is recommended to effectively navigate the complexities of trusts and tax regulations. When evaluating estate planning options, it is essential to weigh the pros and cons of trusts, as they can significantly influence beneficiaries’ financial situations. Thorough consideration of these factors, combined with professional guidance, ensures that the chosen approach aligns with long-term goals and minimizes potential tax liabilities. Ultimately, a well-structured trust can provide peace of mind and financial security for loved ones, but careful planning is key to maximizing its benefits. Additionally, understanding inheritance tax benefits is crucial when deciding on the appropriate structure for your estate. This knowledge can empower individuals to make informed decisions that not only protect their assets but also ensure that their beneficiaries receive the maximum possible financial support. Ultimately, being proactive in estate planning and fully grasping the nuances of trusts and taxation can lead to more favorable outcomes for families in the long run.
What to Do:
• Speak with an independent financial adviser and/or estate planning solicitor before setting up a trust.
• Understand the ongoing responsibilities of trustees, reporting requirements, costs and potential tax consequences.
• Consider whether a trust adds value compared to simpler alternatives like direct beneficiary nominations.
5. Maximise Your Inheritance Tax Allowances
Even with pensions included in your estate from 2027, you may be able to reduce or eliminate your inheritance tax bill by using available allowances:
• Nil-rate band: £325,000 per person (can be transferred between spouses).
• Residence nil-rate band: Up to £175,000 if passing on the family home to direct descendants (can be transferred between spouses) and your estate is less than £2m.
• Spouse exemption: Transfers between spouses and civil partners are generally inheritance tax-free.
• Business and agricultural reliefs: These are higher risk and not suitable for everyone and may apply in some cases where the estate includes qualifying assets.
What to Do:
• Ensure your Will is structured to make the most of these allowances.
• Consider using life insurance in trust to cover any expected inheritance tax liability. Additionally, it’s beneficial to review your estate plans regularly to adapt to any changes in tax laws or personal circumstances. Exploring options such as charitable donations can also be advantageous, as these may further reduce the overall tax burden. By carefully evaluating all factors, you can enhance barry’s inheritance tax arrangements, ensuring a more favorable outcome for your heirs. It’s also important to communicate your wishes clearly to your heirs, as misunderstandings can lead to disputes and unintended tax consequences. Be aware of the inheritance tax impacts on individuals, as this can vary significantly based on personal situations and assets. Engaging with a financial advisor can provide tailored strategies to optimize your estate plan and minimize tax liabilities effectively. Additionally, staying informed about the impact of inheritance tax changes is crucial, as these modifications can significantly influence your estate planning strategies. Regular consultations with a financial professional can help you navigate these complexities and ensure that your estate remains compliant while minimizing tax exposure. Ultimately, proactive planning not only safeguards your assets but also preserves your legacy for future generations.
6. Get Independent Professional Advice Tailored to Your Circumstances
Perhaps the most important step you can take is to sit down with an independent financial adviser. The right strategy depends on many factors — your age, income needs, total wealth, family situation, and appetite for complexity.
What to Do:
• Book a financial review to model the impact of the changes on your estate from 6th April 2027.
• Discuss pension drawdown strategies, gifting plans, and alternative investment options.
• Revisit your plan regularly to reflect changes in legislation, markets, and personal priorities.
Don’t Wait Until the Rules Change
The changes coming from 6th April 2027 could have a major impact on how pensions are passed on. But there’s still time to plan. Reviewing your estate plan now could make a meaningful difference to your beneficiaries, and help you keep more of your wealth in the family.
At Flying Colours Advice, we can help you understand the full picture, assess your options, and build a plan tailored to your goals.
We’re hosting a free Inheritance Tax webinar in June, where our experts will cover key planning tips, answer common questions, and help you navigate your next steps.
Book your place at the webinar now or speak to a Flying Colours Advice adviser for one-to-one estate planning support.