Pension reforms proposed for 2027

In the 2024 Autumn Budget, Chancellor of the Exchequer Rachel Reeves introduced proposals that could significantly reshape the treatment of pensions for inheritance tax (IHT) purposes. While no changes have been enacted yet, the publication of draft legislation marks a clear step toward bringing unused pension funds within the scope of IHT from 6 April 2027.[1]

For now, the existing rules remain unchanged, and no immediate action is required. However, if mitigating IHT is a key concern, it is wise to stay informed and begin considering how these potential changes could affect your estate planning strategy. Now is a good time to speak to your financial adviser.

Why pensions have been a strategic asset historically

Under current legislation, defined contribution pensions offer notable tax advantages in estate planning. In particular, unused pension funds up to £1,073,100 (or more with LTA protections) can be passed to beneficiaries free of IHT and income tax if the individual dies before age 75 and the funds are transferred within two years.[2] This is the lump sum and death benefit allowance, LSDBA, that replaced the lifetime allowance in 2024. There are several things that may reduce this, such as if you have already taken tax-free cash payments from your pension or a serious ill-health lump sum. Even if death occurs after age 75, these funds are typically only subject to income tax when accessed by beneficiaries, often at their marginal rate.

Owing to these features, pensions have become a widely used and effective tool for intergenerational wealth transfer. Many individuals have chosen to preserve their pension funds while drawing income from other assets, knowing that pensions currently sit outside the estate for IHT purposes.

What will change in April 2027?

The government’s proposed reform will bring some pension savings back into the IHT net. Specifically, the unused value of defined contribution pensions at the time of death will, from April 2027, be treated as part of the deceased’s estate. This means they may be subject to the standard 40% inheritance tax rate where applicable.[3]

That is a big shift, especially for those who pass away after the age of 75. Right now, beneficiaries already pay income tax on withdrawals from inherited pensions, usually at their marginal rate. Under the new rules, the unused value of the pension will also be included in the estate for IHT purposes, even if the scheme has discretionary benefits.

At first glance, this looks like two layers of tax on the same pot, inheritance tax at the top, and income tax when the funds are taken out. However, the draft legislation introduces a safeguard to prevent full double taxation.

If inheritance tax has been paid on a pension death benefit, the beneficiary can claim an income tax deduction against future withdrawals. The deduction is capped at the lower of the inheritance tax paid or the taxable income withdrawn in that year, with any excess carried forward to offset later withdrawals.[4]

In practice, this means that while pensions will now be within the IHT net, beneficiaries will not usually pay both full IHT and full income tax on the same funds. For example, a higher rate taxpayer inheriting a pension that has been subject to IHT may see the income tax on their withdrawals reduced, and in some cases eliminated, by applying this deduction.

The result is that the feared effective tax rates of 67–70% are unlikely to apply in most cases.[5] Instead, the combined tax burden will depend on the size of the estate, the amount of IHT paid, and how quickly the beneficiary chooses to withdraw the inherited pension.

Initial concerns over the complexity of the original proposals, particularly regarding potential delays in estate administration, appear to have been partly addressed. Under the revised draft, the responsibility for reporting and settling IHT on pension death benefits will shift from scheme administrators to the deceased’s personal representatives. However, ambiguity remains around how schemes will practically facilitate IHT payments to HMRC, with some administrative processes still to be clarified.

Importantly, the government confirmed that all death in services schemes, regardless of how they’ve been provided, will not be subject to IHT.

According to the government, these changes are aimed at closing perceived loopholes and promoting fairness across asset classes. It is important to note that these reforms remain in draft form and are subject to potential amendments before being enacted.

Wider pension reforms on the horizon

These inheritance tax related changes are part of a broader set of pension reforms included in the government’s draft Pension Schemes Bill.[6] Other potential changes expected between 2027 and 2030 include:

• The introduction of value-for-money assessments across workplace schemes, intended to improve transparency and performance for savers.
• The consolidation of small pension pots to reduce administrative inefficiencies and lost accounts.
• A requirement for pension schemes to provide default decumulation pathways to help retirees manage income sustainably.
• Greater investment in UK assets through pension funds, as part of a wider initiative to support domestic growth.

While these broader reforms are primarily aimed at improving outcomes for the average pension saver, the IHT proposal is particularly relevant for high net worth individuals who use pensions as part of their estate planning.

Who might be impacted?

The changes are not expected to affect all pension savers equally. The most significant impact would be felt by individuals with large defined contribution pension pots that are unlikely to be fully drawn upon during their lifetime.

To put this into perspective, under the current rules, the nil-rate band, the portion of an estate that is not subject to IHT, is £325,000 per individual, or £650,000 for a couple (if none of the £325,000 was used when the first partner of the couple died).[7] In addition, many estates may benefit from the residence nil-rate band, which can add up to £175,000 per person when passing a main residence to direct descendants, taking the total potential exemption to £500,000 per person or £1 million per couple.[8]

When unused pension funds are brought within the estate for IHT purposes, individuals whose total estate value, including their pension pot, exceeds these thresholds would be affected. For example, an individual with £900,000 in non-pension assets and a £600,000 pension fund would previously have had only the £900,000 considered for IHT. Now, with pensions included, their entire £1.5 million estate would be subject to IHT, significantly increasing their potential tax liability.

According to HMRC estimates (prior to the draft legislation), approximately 10,500 estates could face an IHT charge on pension funds for the first time, while around 38,500 estates that already pay IHT might see their liability increase.¹

For many retirees who use their pensions to fund retirement and gradually draw down their pot, there may be little to no change (as IHT would only apply to the unused portion remaining at death). That said, for those who are preserving their pension wealth as a legacy asset, this change will alter the tax efficiency of their approach.

Impact on estate planning

While nothing will change until 2027, speaking to your financial adviser now to explore how your current plans will be affected is recommended. Strategies worth discussing could include:

• Reviewing the balance between pension and non-pension assets in your estate.
• Assessing whether it may be appropriate to draw more from pension savings earlier in retirement, particularly if other assets are already IHT-efficient (e.g., AIM shares or trusts).
• Evaluating whether gifting strategies, such as gifting out of excess income, or trust arrangements could play a more prominent role in your long term planning.
• Exploring wider estate planning strategies, where alternative tax-efficient investments, such as offshore bonds, may be considered. Offshore bonds can offer flexibility, allowing you to assign policy segments to beneficiaries over time. This can gradually reduce the value of your estate for inheritance tax purposes, although gifts may be subject to the seven-year rule and other tax considerations.
• Ensuring that your pension nomination forms and will are up to date and structured to reflect any future tax landscape.
• It may also be worth modelling different estate scenarios under both the current and draft rules to understand potential tax exposures and opportunities for mitigation.

What should you do now?

Ultimately, nothing has changed yet and won’t until April 2027. As such, there is no immediate need to act, and any planning changes you make now should be made with care and professional advice. That said, early awareness is valuable. If you are likely to be affected by these reforms, it is strongly encouraged you speak to a financial adviser. Beginning the process of reviewing your pension strategy now, within the context of your wider financial plan, can ensure you’re well prepared to respond confidently when the reforms take effect.

This is also an opportune time to speak with close family members, particularly those who may act as your lasting power of attorney (LPA) or be involved in managing your affairs later in life. Ensuring they understand your intentions and the implications of these changes can help avoid confusion and support more informed decisions.

Being prepared does not mean acting prematurely, but it does mean thinking ahead.

Moving forward

The draft 2027 pension reforms serve as a timely reminder that tax legislation is always evolving. For many, pensions have been a central element of tax-efficient wealth transfer, and any change to that status quo can have material consequences. While there is no need for immediate action, being informed and prepared is key. As always, we recommend working with your financial adviser to ensure your strategy remains aligned with your long term goals and ready to adapt.

The Financial Conduct Authority does not regulate Tax, Trust & Estate Planning, Will-writing or Cashflow modelling.