A major shake-up is coming to how pensions are taxed on death. From April 2027, unused pension pots will be brought into scope for inheritance tax—regardless of how complex the situation may be. Many families may soon find themselves facing unexpected tax bills, tighter deadlines, and more administrative pressure during already difficult times. And with HMRC yet to build the necessary systems, this could become one of the most confusing tax changes in recent memory.
So What’s Changing? Will it affect you?
When the proposed changes are effective, unused pension pots will now fall within the scope of inheritance tax. This applies to both UK-based and qualifying overseas pension schemes. Inheritance tax must be paid within six months of death, and the responsibility for reporting and payment rests with the personal representatives of the estate.
For those over 75, there’s more. Beneficiaries may also pay income tax on inherited pension income unless specific directions are made to scheme administrators. If not handled properly, the same pot may face double taxation.
The new rules will apply to anyone inheriting a pension pot. They will affect the estates of individuals who die on or after 6 April 2027. Personal representatives of the estate will be responsible for managing the tax implications. Beneficiaries of those who die aged seventy-five or over may also face income tax liabilities. Pension scheme administrators will be affected indirectly through administrative and reporting requirements.
Spouses, civil partners and charities will still be exempt. But everyone else needs to take note—nearly 40,000 estates a year could pay an extra £34,000 in tax on average.
What to do? How to Get Ready?
So what can we do about the pension tax change coming in 2027? The truth is, this change makes pension planning more complex—but not impossible. The goal now is to minimise both inheritance tax (IHT) and income tax as far as legally possible, by acting early and structuring things sensibly. Previously, if you passed away with pension savings, only income tax might apply—and often not at all. But from April 2027, IHT will apply to unused pension pots, and income tax will also apply if you die aged 75 or older. Here’s a clearer breakdown of what you can do:
1. Use the 25% Tax-Free Lump Sum Early.
Once you reach pension age, consider withdrawing the 25% tax-free entitlement.
- If you crystallise the pot (via drawdown or annuity), you can take 25% of the full pot tax-free upfront.
- If you don’t crystallise and use flexible lump sums (UFPLS), 25% of each withdrawal is tax-free instead.
This tax-free cash can be transferred into a discretionary trust (more on this below), gifted to family (if you survive 7 years, it becomes IHT-free) or used to support your own lifestyle or early retirement.
2. Consider Using Discretionary Trusts.
If you don’t want to give the lump sum away immediately, you can place it into a discretionary trust.
- Trusts are outside your estate for IHT after 7 years.
- But amounts above the £325,000 nil-rate band attract a 20% lifetime IHT charge upfront.
- If you die within 7 years, there could be a top-up to 40%, but credit is given for tax already paid.
- You won’t get the 20% back even if you survive 7 years.
Trusts can be useful for protecting family wealth, keeping control over how funds are used and delaying inheritance for young or vulnerable beneficiaries.
3. Withdraw Strategically Each Year.
To minimise income tax while still using your pension:
- Withdraw gradually each year, keeping your total income below £50,270 (basic rate band in 2025/26).
- The first £12,570 is tax-free (personal allowance), and the next £37,700 is taxed at 20%.
- Avoid large one-off withdrawals that push you into the 40% or 45% tax brackets.
This is especially useful for those:
- Not reliant on the full pension for living costs
- Looking to pass wealth on gradually
- Planning long-term gifting strategies
4. Start Gifting Early.
If you’ve already taken out some of your pension:
- Gift small amounts using annual allowances (£3,000 per year, per person)
- Make regular gifts from excess income (these are IHT-free immediately if structured properly)
- Consider larger gifts, which are PETs (Potentially Exempt Transfers) and become IHT-free after 7 years
Gifting during your lifetime reduces the value of your estate and can ease future tax burdens for your family.
5. Update or Create a Will.
Regardless of your age or wealth, you should have a clear, updated will.
- Name executors to handle your estate
- Specify how any IHT is to be paid (e.g. from estate assets, not from beneficiaries)
- Coordinate your will with your pension nominations, which sit outside your will but affect estate planning
- Ensure your wishes are practical and tax-efficient
If your estate is likely to include an unused pension pot after 2027, make sure your will reflects how this will be handled.
Pensions are one of the most complex areas of tax and estate planning—especially with these new rules. A professional adviser can help you to model different scenarios suiting your requirements, minimise both IHT and income tax exposure, structure gifts or trusts efficiently and align your pension strategy with your overall estate plan.
These changes mean that leaving your pension untouched isn’t always the most tax-efficient option anymore. What used to be a smart way to pass on wealth is now a potential tax trap. It’s not about rushing to withdraw everything—it’s about having a smart, personalised plan based on your income, family situation, and future goals. Draft legislation is open for comment until 15 September 2025. But the direction is clear: pensions are no longer outside the reach of IHT. Time to re-evaluate those “tax-free” plans before 2027 creeps up.