Significant changes are coming to how pensions are treated when someone dies, potentially affecting the inheritance tax implications for beneficiaries.
The draft Finance Bill 2025 proposes that, from 6 April 2027, some pension funds will count as part of a person’s estate for inheritance tax (IHT).
For many, pensions have been a tax‑efficient way to pass on wealth. However, these proposed rules reduce that advantage for some families, increasing the role of inheritance tax.
What’s Changing?
Currently, most unused pensions don’t form part of your estate for IHT. This allows them to pass to beneficiaries without inheritance tax.
The new draft rules will treat some pension death benefits as part of your estate. This means you could face a 40% IHT bill if the estate exceeds the inheritance tax threshold.
Which Pensions Are Affected?
The changes cover:
- UK registered pension schemes
- Qualifying overseas pension schemes
- Section 615(3) schemes (for some overseas employments)
They include lump sums, continuing payments, and other post‑death payouts.
What’s Not Affected?
Some benefits remain outside the IHT rules:
- Death‑in‑service benefits (if you die while still employed)
- Dependants’ scheme pensions (pensions payable to a spouse or child based on dependency)
Who Pays the Inheritance Tax?
Usually, executors (personal representatives) pay the inheritance tax.
Under the draft new rules, beneficiaries can ask the pension scheme administrator to pay the inheritance tax directly from the pension before they receive their share.
If the IHT bill is £4,000 or more, the scheme must pay it if requested. For smaller bills, this remains optional.
What About Income Tax?
Some pension payouts are taxable as income.
The draft rules add a deduction system (s.567B) to prevent double taxation. If too much IHT gets paid and later refunded, the refund counts as pension income in the year it is received.
When Do These Rules Apply?
The changes apply to deaths on or after 6 April 2027.
What Does This Mean in Practice?
Here’s a simple example:
- Before the draft rules:
A £200,000 death benefit with a £50,000 IHT bill left around £73,168 net after all taxes – an effective tax rate of 63.4%. - Under the new rules:
With the deduction, the net amount rises to about £101,325, cutting the effective tax rate to 49.3%.
That’s a significant difference, but it still imposes a substantial tax burden on larger estates under IHT.
Why Planning Matters More Than Ever For Inheritance Tax
These rules make proactive planning essential:
- Review your estate plan: If your pension is a large part of your wealth, check its IHT impact.
- Talk to your provider: See if your scheme offers beneficiary drawdown. Without it, your planning options are limited.
- Manage withdrawals carefully: Taking benefits gradually can lower tax. For instance, drawing £30,000 a year, as in this example, might reduce PAYE in the early years.
- Unmarried couples: If you’re married or in a civil partnership, your pension and other assets usually pass to your spouse free of IHT. But for unmarried couples, this exemption doesn’t apply. That means your partner could face a much larger IHT bill on any pension benefits you leave them.
Our Takeaway
The draft rules create a fairer system by avoiding double taxation. However, they also bring pensions into the inheritance tax net for many families.
With careful planning – especially around beneficiary drawdown and income management – you can reduce the inheritance tax burden and pass on more wealth to your loved ones.
Final Thoughts On Inheritance Tax
Tax rules are complex, and these changes underline the need for good estate and retirement planning to manage Inheritance Tax effectively.
If pensions form a significant part of your estate, seek advice now to make sure your plans are ready for 2027.
At Manning Gee Investments, we can help review your arrangements and explore strategies to minimise inheritance tax for your beneficiaries.
General disclaimer: We sourced the data from external providers. While we strive for maximum accuracy, we cannot guarantee the reliability of the data they supply. The author writes the introduction from their perspective, reflecting their views, which may not align with those of Manning Gee Investments. Anyone considering a product or service based on this blog should seek professional advice or conduct their own research before deciding. The author bears no liability for decisions made based on this blog. Investments can rise and fall in value, and the return at the end of the investment period is not guaranteed—you may receive less than you originally invested.