Pensions and Inheritance Tax from 2027: Why It’s Time to Plan—Not to Panic

The world of pensions and investments is rarely straightforward. Even the most financially confident individuals can find themselves overwhelmed as rules evolve year after year. With each Budget announcement comes a new layer of regulation to understand and assess—particularly when it affects something as important as your long-term estate planning.

One of the most significant changes announced in the 2024 Budget was the proposal to bring pension death benefits into the inheritance tax (IHT) net from April 2027. For many households, this marked one of the biggest shifts in recent years—primarily because using pension wealth to pass money tax efficiently to beneficiaries has long been a cornerstone of traditional estate planning.

It is entirely understandable that the announcement caused uncertainty. But while the headlines may be unsettling, it is essential to approach the changes with clarity rather than fear. The details of the legislation are still emerging, and reacting too quickly could, in some cases, lead to unnecessary tax consequences.

This blog breaks down what is known so far, what remains unclear, and what steps you can take today to prepare—calmly, strategically, and without disrupting your long-term financial plan.

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Why Now Is the Time to Plan—Not Panic

The Chancellor’s proposal means that more estates could fall within the IHT net from 2027, since pension funds are often one of the largest assets people hold.

But there is a crucial distinction between being aware of the changes and taking action prematurely.

For example:

• Withdrawing pension funds early can trigger significant income tax liabilities, particularly for higher-rate and additional-rate taxpayers.
• Once money leaves a pension wrapper, it loses its tax-efficient growth environment, which can reduce the long-term value of your wealth.
• Early withdrawals can disrupt planned retirement income strategies, leaving individuals worse off in later life.

Every year, rumours circulate suggesting the 25% tax-free lump sum might be reduced. This leads many people to act hastily—only to find the benefit was never touched, leaving them with a cash lump sum they did not need and a higher tax liability on future gains.

When it comes to complex tax reform, the calmest approach is often the most effective.

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What the Government Has Proposed—and Why It Matters

Under current rules, pension funds generally sit outside the estate for IHT purposes:

• If someone dies before age 75, death benefits are typically tax-free for beneficiaries.
• If they pass after age 75, beneficiaries pay income tax on withdrawals, but not inheritance tax.

From April 2027, the proposed reforms would change this position. Based on the announcements so far:

• Unspent pension funds passed to beneficiaries may become subject to inheritance tax.
• The standard 40% IHT rate may apply if the total estate value—now including pension assets—exceeds available thresholds.
• IHT thresholds remain frozen until April 2031, meaning more families could be affected each year purely through asset growth.

The key IHT thresholds continue to be:

• £325,000: Nil-rate band
• £175,000: Residence nil-rate band (where available)

For many families, pensions helped keep total estate values under these limits. With the reforms, long-established assumptions may now need reviewing.

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What Was Clarified in the 2025 Budget?

The 2025 Budget announcements provided further detail on how pension death benefits may be treated:

• Unused pension funds will form part of the deceased’s estate, even where trustees previously had discretion over beneficiaries.
• Death-in-service benefits will remain excluded from IHT.
• Benefits passing to a surviving spouse, civil partner, or registered charity will continue to qualify for exemption.
• Personal representatives may request pension scheme administrators to withhold up to 50% of taxable benefits for up to 15 months to help meet IHT liabilities in certain cases.

While helpful, these details still leave several key questions unanswered—meaning final decisions should wait until legislation is confirmed.

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Why Immediate Action Could Backfire

As tempting as it may be to “act before the rules change”, moving too quickly could be counterproductive.

Here are some common risks of rushed decisions:

1. Higher Income Tax Exposure

Large withdrawals may push you into a higher marginal rate, reducing the net value significantly.

2. Loss of Tax-Advantaged Growth

Pensions offer a uniquely efficient environment for long-term growth. Removing funds early shifts wealth into a potentially IHT-exposed environment.

3. Damage to Long-Term Planning

Ad hoc withdrawals may disrupt retirement income strategies that have been carefully built to last decades.

Often, the desire to “avoid future tax” can create substantial—and unnecessary—tax costs today.

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Practical Steps You Can Take Now

While it is too early to implement major structural changes, there are several steps that can strengthen your financial preparedness:

1. Model Your Estate

Produce scenarios both including and excluding pension assets to see whether IHT would realistically apply.

2. Review Gifting and Legacy Plans

Your strategy may still be effective—or you may need to consider trusts, staged gifting, or life cover written in trust to mitigate future liabilities.

3. Explore Long-Term Drawdown Strategies

For some people, phased withdrawals in future years may be more tax-efficient than reacting now.

4. Assess Your Overall Asset Mix

Balancing pensions, ISAs, property and other investments can help reduce future exposure.

5. Work With a Specialist Adviser

A professional can run cash-flow modelling, estate simulations and scenario testing—helping you make decisions based on evidence, not emotion.

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Scenario Examples: Why Caution Is Essential

Below are simplified illustrations demonstrating the potential risks of impulsive action.

1. Moderate Pension Pot

Mark has a £280,000 pension and owns a modest flat. Even if pensions are included in IHT from 2027, his total estate may remain under the thresholds.

If he withdraws £100,000 now in fear of future IHT:

• He triggers higher-rate income tax
• He loses the pension’s tax-advantaged environment
• He pays tax today for a problem he may never have

2. Large Pension Value

Priya has a £1.2m pension and is more likely to face IHT. However, withdrawing £400,000 today triggers substantial income tax. Waiting for final legislation could allow her to plan more efficiently.

3. Married Couples

Jim worries about his children’s future IHT liability. But pensions passing to a surviving spouse remain exempt. Withdrawing funds early creates an unnecessary income tax bill.

These examples highlight a simple truth: more damage is often caused by reacting too quickly than by waiting for clarity.

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What to Watch for in Final Legislation

Key areas to monitor include:

• How pension assets will be valued for IHT
• Whether any exemptions or reliefs will apply
• Transition rules for those already in drawdown
• Whether different pension types will be treated differently
• How the reforms link with wider pension simplification plans

These details will determine the true scale of the impact.

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Key Takeaways

• The proposed changes to pensions and inheritance tax from 2027 are significant, but they do not require immediate action.
• Reacting prematurely—particularly by withdrawing pension funds—may create greater tax costs than the future IHT liability itself.
• Strong planning, careful modelling and regular reviews can help ensure your long-term strategy remains efficient, flexible and resilient.
• Professional guidance is essential as further information emerges.

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Planning With Confidence

Your pension is one of your most valuable assets—both for your retirement and your legacy. Understanding how future policy changes may impact you is important, but decisions should always be grounded in evidence, clarity and holistic planning.

If you would like support modelling the potential impact of the 2027 inheritance tax changes on pensions, or reviewing your long-term estate strategy, our planners are here to help.