Pensions, IHT and Gifting

For years, pensions have been one of the most effective ways to pass on wealth. They’ve sat outside the estate for Inheritance Tax (IHT), allowing funds to move tax-free to the next generation.

That long-standing advantage is now set to end. From 6 April 2027, any unused pension funds left on death will be counted within the estate for IHT. The government confirmed the change in the Autumn Budget 2024, and draft legislation has since been published.

Once the new rules take effect, pensions will face the same 40 per cent inheritance charge as other assets. If death occurs after age 75, there will also be income tax when beneficiaries draw the funds. Combined, that can mean an effective rate close to two-thirds. And for estates over £2 million, the loss of the residence nil-rate band can push the total tax higher still.

How This Alters the Landscape

Under current rules, many families treat pensions as the “last pot” to touch—used only after other savings have been spent or gifted. That approach made sense when pensions sat safely outside IHT. From 2027, the logic reverses. Keeping large balances in a pension could increase, rather than reduce, the tax on your estate.

The change is especially relevant for those who already have more than enough to fund retirement. They may now face a choice between leaving funds inside the pension and accepting the IHT charge, or drawing money out and managing the position while still alive.

Thinking About Gifts

If the income tax cost of a withdrawal is manageable, gifting some of the pension money can be an effective way to reduce the taxable estate.

There are two main routes. The first is straightforward: draw funds from the pension and give them away—either to family or into a trust. Gifts to individuals normally fall out of the estate after seven years; gifts into trust follow similar timing but may have entry charges if large enough.

The second route is subtler: regular gifts made from surplus income. These can qualify for the long-standing “normal expenditure out of income” exemption. When the conditions are met, the gifted income is outside the estate immediately, with no seven-year wait. You’ll still pay income tax on the pension withdrawal, but the IHT advantage is instant.

To meet HMRC’s test, the gifts must be part of your usual spending pattern, paid from genuine income (not capital), and leave you with enough to maintain your normal lifestyle.

Practical Realities

HMRC expects evidence. Executors will need to show a record of income, spending, and gifts when the time comes. Keeping a simple log—dates, amounts, and where the money came from—can make the exemption straightforward to claim.

If the gifts don’t qualify, it’s worth comparing tax rates: your own income tax on withdrawal versus the rate your beneficiaries would pay if inheriting the pension later. If they fall into lower income tax bands, it may still be more efficient to leave the funds untouched.

And some things remain unchanged. Assets left to a spouse or civil partner will still be free of IHT, including pensions. But if your Expression of Wish currently bypasses your spouse, it’s worth reviewing before the new rules take hold.

What to Do Now

This change reshapes how pensions fit into estate planning. It removes the automatic tax shelter that once made them a simple tool for passing wealth.

The next two years provide a window to review strategy—decide what income you truly need, consider whether gifting fits your circumstances, and ensure your paperwork reflects your current wishes.

Taking measured action before April 2027 can give you more options later and reduce the likelihood of a large, avoidable tax bill landing on your estate.