Inheritance Tax Pension Changes Deliver a Triple Blow From 2027

The inheritance tax pension changes taking effect from 6 April 2027 will expose some families to a triple tax hit that did not exist before: inheritance tax (IHT) on unused pension funds, income tax on those same funds if the deceased was 75 or older, and the loss of the residence nil-rate band. The Finance Act 2026, which received Royal Assent on 18 March 2026, made these changes law, amending the Inheritance Tax Act 1984 and two other statutes.

What the Inheritance Tax Pension Changes Actually Mean

Under the current rules, unspent defined contribution pension funds sit outside a person’s estate for IHT purposes. From April 2027, most unused pension wealth will be counted. The government estimates that around 213,000 estates with inheritable pension wealth will be affected in 2027 to 2028; of those, 10,500 estates, or around 1.5% of all UK deaths, will become liable for IHT where they previously would not have been, according to David Gray LLP.

The mechanics compound quickly. Everyone has a nil-rate band of £325,000, beneath which estates pay no IHT. A further £175,000 residence nil-rate band (RNRB) applies when a home passes to a direct descendant. The RNRB tapers away at £1 for every £2 an estate exceeds £2 million. For a single person, the RNRB disappears entirely once the estate reaches £2.35 million; for a couple sharing both nil-rate bands, the threshold is £2.7 million.

The complication after April 2027 is that pension wealth, which previously sat outside the taper calculation, will now be counted towards that £2 million threshold, according to Clarity Global. A couple whose non-pension estate is comfortably below £2 million could find their pension pot pushes them above it, wiping out the RNRB they had assumed was intact. There is no separate pension nil-rate band under the new rules.

Pensions left to a surviving spouse or civil partner still benefit from the spousal exemption. Gifts to charity are also exempt. Death-in-service lump sum benefits are excluded from the new regime entirely, as Baggette + Co confirms. If the scheme member dies before 6 April 2027, the old rules apply even if pension benefits are paid out after that date.

NFU Mutual has calculated how the combined charges land for a married couple with £2 million of assets and pension pots totalling £700,000.

Source: NFU Mutual

Adam Cole, retirement specialist at Quilter, said: ‘The prospect of some families facing an effective tax rate of over 90% on inherited pension wealth highlights just how significant the inheritance tax changes coming in from April 2027 will be. While these are quite extreme scenarios, many more families will find pensions that were previously outside the inheritance tax net are now contributing to much larger tax bills.’

IHT receipts are already running at approximately £9 billion in the 2025–26 tax year, based on OBR estimates cited by NFU Mutual. The pension changes will add further pressure over time.

Administration Mechanics Families Need to Understand

The legal and administrative burden under the new rules falls on personal representatives (PRs), who become responsible for calculating and paying IHT on unused pension funds. Interest accrues on unpaid IHT after six months from death; penalties can apply from twelve months, according to A&O Shearman. Pension scheme administrators must provide information on the value of unused funds within four weeks of being notified of a death, under a requirement introduced by the new legislation, as set out by Legal & General.

A new mechanism called the pensions direct payment scheme allows the IHT liability to be paid directly from pension benefits, provided the amount owed is at least £1,000. PRs can also issue a withholding notice that temporarily holds back up to 50% of the pension benefits subject to IHT for up to 15 months after the end of the month of death.

Strategies to Reduce Exposure to the Inheritance Tax Pension Changes

Gifting remains the most straightforward lever. You can give away up to £3,000 per financial year under the annual exemption. Regular gifts from surplus income, ones that do not affect your standard of living, qualify for immediate exemption under the expenditure-out-of-income rule, with no seven-year survival requirement. Most other gifts require the donor to survive seven years to fall outside IHT entirely.

Sean McCann, chartered financial planner at NFU Mutual, said: ‘Making gifts during your lifetime is one of the most effective ways of reducing inheritance tax. While some gifts are immediately exempt, including gifts up to £3,000 each tax year and regular gifts from income that don’t compromise your normal standard of living, most others require you to survive seven years. In many circumstances it will be possible to take out a life insurance in trust to meet any potential inheritance tax liability on the gift.’

Drawing the 25% tax-free lump sum earlier is another option. You can withdraw up to £268,275 tax-free from age 55 (rising to 57 from April 2028). Taking it sooner reduces the pension pot that will sit within the estate, though the trade-off is a smaller fund left to grow.

Annuities deserve a second look. Sales rose 7.8% from 82,061 in 2023/24 to 88,430 in 2024/25, according to the Financial Conduct Authority. Buying an annuity converts pension capital into income, removing the asset from the estate. Ed Wood, financial planning director at Rathbones, said: ‘We would not advocate annuity purchases simply to avoid future inheritance tax, but the relative merits of annuity vs drawdown have slightly changed. For anyone who had previously ruled this out, it may be worth a second look.’

The RNRB taper is the mechanism to watch most carefully in the near term. For anyone sitting just below the £2 million threshold, adding pension wealth to the calculation after April 2027 may be the change that tips them over. Reviewing whether pension drawdown, gifting, or annuity conversion can keep the combined estate below that line is the most pressing task before the legislation bites.