Pension Funds and Inheritance Tax: Planning Before and After the 2027 Reform

For decades, a defining feature of UK pension planning has been the inheritance tax status of defined contribution (DC) pension funds: money held in a DC pension scheme sits outside the estate on death, passing to nominated beneficiaries free from IHT. Combined with pension freedoms introduced in 2015 — which removed the obligation to buy an annuity and allowed pension funds to be passed down generations in drawdown — this made the pension the single most powerful IHT mitigation tool available to most UK taxpayers.

The October 2024 Budget announced the end of this advantage. From 6 April 2027, unspent DC pension funds will be brought within the scope of UK inheritance tax. This is one of the most significant changes to the UK's estate planning landscape in a generation, and it requires immediate review of pension, investment, and estate planning strategies.

The Current Position (Pre-April 2027)

Until 5 April 2027, the position remains as follows:

Defined contribution pension funds (personal pensions, SIPPs, workplace DC pensions) do not form part of the deceased's estate for IHT purposes. On death:

• If the pension holder dies before age 75: the fund can be passed to nominated beneficiaries as a lump sum or placed into drawdown, and the payment is completely free of income tax and IHT
• If the pension holder dies aged 75 or over: beneficiaries can receive the fund as a lump sum or drawdown, and the amount received is taxed at the beneficiary's marginal income tax rate — but there is no IHT charge

Under the current rules, a pension fund of £500,000 held by a wealthy individual who has already utilised their IHT nil-rate band passes to their children entirely free of IHT. For a person with a £500,000 pension, this is equivalent to a saving of £200,000 of IHT (£500,000 × 40%) compared to holding the same amount in an investment account.

The Pension in an IHT-Efficient Estate Plan (Current Rules)

Under current rules, the rational estate planning approach for most retirees in drawdown is to spend non-pension assets first — retaining the pension fund as long as possible, knowing it will pass outside the estate. This reverses conventional wisdom about pension planning, which would otherwise suggest spending pension funds first to minimise future income tax on benefits (given the pre-75 death tax advantage).

Specifically:

• Draw income from ISAs, GIAs, and taxable savings accounts before touching the pension
• Maintain the pension in drawdown rather than buying an annuity (which would extinguish the IHT advantage on death)
• Ensure pension nominations are up to date and reflect the desired succession

The pension effectively functions as a tax-efficient estate asset as well as a retirement income vehicle — a dual role no other mainstream UK product replicates.

The 2027 Reform: What Is Changing

The Autumn Budget 2024 announced that from 6 April 2027, unused DC pension funds and death benefits from DC arrangements will be included in the deceased's estate for IHT purposes.

The measure was confirmed in the Finance Act 2026 and takes effect from 6 April 2027. The broad effect is:

• The value of the undrawn pension fund at death will be added to the taxable estate
• IHT at 40% will apply to the portion of the combined estate (including the pension) above the available nil-rate band(s)
• A double tax risk arises where beneficiaries may face both IHT on the pension fund (as part of the estate) and income tax when they draw the funds down (at their marginal rate). This interaction is complex and remains a significant planning concern
• Personal representatives of the estate are liable for the IHT on the pension element, working alongside pension scheme administrators to value and report the funds

The detailed mechanics — including how pension administrators report values and how the IHT is collected and apportioned between the estate and the scheme — were settled in the Finance Act 2026 legislation, with HMRC guidance continuing to be updated ahead of the April 2027 commencement.

Illustrative Impact

Consider an individual with:

• Non-pension estate: £800,000
• DC pension fund: £500,000
• Total: £1,300,000

Current rules (pre-2027): IHT on estate = (£800,000 − £325,000 NRB) × 40% = £190,000. Pension fund passes IHT-free.

Post-2027 reform: IHT on estate = (£1,300,000 − £325,000 NRB) × 40% = £390,000. An additional £200,000 of IHT is due on the pension element alone.

For an individual with a £1 million pension fund and a fully utilised nil-rate band, the additional IHT exposure from the reform is £400,000.

Planning Actions Before April 2027

The window before April 2027 presents a period in which the current rules still apply. Key considerations:

1. Review Pension Nominations Urgently

Pension death benefit nominations are not covered by your Will — they are separate expressions of wish held by the pension scheme. If your nominations are out of date (naming, for example, an ex-spouse or a deceased parent), they must be updated immediately. Pension trustees have discretion over death benefit payments and will consider nominations as guidance.

With the reform on the horizon, nominations should be reviewed with an eye to structuring death benefits in the most efficient way under both pre- and post-reform rules.

2. Consider Drawing Down Pension in Excess of Immediate Income Needs

Under current rules, it may be worth drawing down more from the pension than you actually need — for example, taking the maximum drawdown that keeps you below the higher-rate income tax threshold — and investing the net proceeds in ISAs or other vehicles. This reduces the pension fund exposed to the post-2027 rules at the cost of income tax today.

The trade-off must be modelled carefully: paying 20% income tax today to avoid 40% IHT later on the same amount is mathematically beneficial — but the maths depend on individual rates, the time horizon, and the investment return on the extracted funds.

3. Gift Pension Income to Children (Potentially Exempt Transfers)

Cash withdrawn from the pension and gifted to children is a potentially exempt transfer — provided the individual survives seven years, it falls outside the estate entirely. Regular gifts out of income (including pension income) may also qualify for the annual gifts out of normal expenditure exemption, which is unlimited in amount and does not require survival of seven years.

4. Lifetime Annuity Considerations

A lifetime annuity eliminates the pension fund value (in exchange for a guaranteed income). Under current rules, this converts an IHT-free pension asset into a taxable income stream — generally a bad trade. Under the post-2027 rules, the trade-off changes: the pension fund becomes IHT-taxable, and the annuity income may represent a broadly similar after-tax value. Annuity pricing and individual health must be factored in; specialist advice is essential.

5. Review Business Property Relief and Other Exemptions

In some cases, pension funds invested in unquoted shares (via a SIPP) may qualify for Business Property Relief — removing 100% from the IHT estate. The interaction of BPR with the post-2027 pension inclusion rules requires specialist advice, as BPR conditions are specific and easily failed.

Post-2027 Planning

Once the reform takes effect, the strategic use of pensions in IHT planning changes substantially. Key adjustments:

• The pension ceases to be an IHT-efficient estate asset in the same way; spending pension assets first (the pre-2015 approach) becomes more rational again for those concerned about IHT
• ISA funds — currently within the estate — become relatively more attractive if the pension IHT advantage is removed
• Pension funding decisions should weigh the income tax on contributions and benefits against the new IHT exposure on residual funds
• Whole-of-life insurance policies written in trust (which remain outside the estate) become more significant tools for IHT liquidity planning
• Discretionary trusts and other structures funded during lifetime become more relevant for estate reduction

Defined Benefit Pensions

Defined benefit (DB) pensions — final salary schemes — are largely unaffected by the 2027 reform in their existing structure. DB pension income ceases on death (or reduces to a spouse's pension). There is generally no capital fund to include in the estate. The reform primarily affects DC and SIPP holders.

Wills and Nomination Review

One of the most urgent practical actions is a comprehensive review of all pension nominations and your Will. These two documents should be aligned to reflect your current family circumstances and your intentions for wealth distribution — taking into account the post-2027 change.

Many individuals have set their pension nominations to reflect a position established 10 or 20 years ago. Life events — divorce, remarriage, the birth of grandchildren, the death of a named beneficiary — may mean nominations no longer reflect wishes. Given the sums involved, this review should not be deferred.

How Global Investments Can Help

The 2027 pension IHT reform affects almost every high-net-worth individual with a substantial DC pension. Global Investments works with clients and their legal and tax advisers to:

• Model the impact of the 2027 reform on the client's specific estate and pension position
• Identify pre-2027 actions — drawdown acceleration, gifting, nomination updates — appropriate to individual circumstances
• Restructure investment and estate plans in light of the reform's changing trade-offs
• Review pension nominations and coordinate with solicitors on Will updates
• Provide ongoing advice as the final legislative details are confirmed

The reform is now legislated in the Finance Act 2026, though HMRC guidance on points of detail continues to be developed. This guide is accurate as of June 2026 and should not be relied upon as legal or tax advice. Always seek qualified professional advice tailored to your specific circumstances. Tax treatment depends on individual circumstances and may change in future. Pension investments can fall as well as rise.

Contact Global Investments to review your pension and estate plan in light of the forthcoming reform.