Pensions and Inheritance Tax: What's changing, and what clients should do now

John Baxter, Law Society (NI) Financial Advice

From April 2027, unused defined contribution pensions (most commonly referred to as personal pensions) will become subject to inheritance tax – a major shift for clients with significant pension pots. John Baxter from Law Society (NI) Financial Advice explains what’s changing, what the risks are (including potential double taxation), and how early planning can help protect wealth and reduce the tax burden on beneficiaries.

In her Autumn 2024 Budget, Chancellor Rachel Reeves introduced a significant shift to the UK’s inheritance tax (IHT) rules. From April 2027, unused defined contribution (DC) pensions will be brought into scope for IHT for the first time. This type of pension is most commonly known as a personal pension and includes pension types such as SIPPs, SSAS and money purchase AVCs.

This change may sound technical, but it could have profound implications for how clients plan their estates, especially those with substantial pension pots. With careful planning, however, there are steps individuals can take to protect wealth and minimise unnecessary tax exposure.

Understanding the current rules

For many clients, pensions may no longer be the pot you preserve, but the one you spend first

Under existing legislation, DC pensions are generally excluded from an individual’s estate for IHT purposes. This has made them an attractive tool for wealth transfer:

• If the pension holder dies before age 75, unused pension funds can be passed on completely tax-free i.e. no IHT or income tax is payable.

• If death occurs at or after age 75, beneficiaries pay income tax on withdrawals at their marginal rate, but no IHT is due.

This favourable treatment has encouraged many to preserve pension savings by using other assets for living expenses so that pensions can be passed on as tax-efficient inheritance.

What’s changing and why it matters

From April 2027, the value of any unused DC pension will count towards the value of the estate for IHT purposes. If the total estate, including the pension, exceeds the £325,000 nil-rate band (or £650,000 for a couple), 40% tax will apply on the amount above the threshold.

The spousal exemption still applies. Pensions passed to a spouse or civil partner remain free of IHT.

The Government estimates this will affect around 8% of estates annually, increasing the IHT bill for roughly 40,000 families. The average additional tax is expected to be £34,000. However, for wealthier families with significant pension funds, that tax consequence will be far higher.

Implications for estate planning

The change brings with it a number of key considerations:

1. Double Taxation Risk. If someone dies aged 75 or over, their pension could now be taxed twice – first through IHT, then again when beneficiaries withdraw funds (as income tax). The combined tax burden could reach as high as 67% in some cases.

2. Probate Delays. Including pensions in the estate may delay probate, especially where beneficiaries are relying on pension funds for liquidity.

3. Rethinking Retirement Spending. Many individuals may now choose to draw down their pensions during their lifetime to reduce the size of their estate, reversing the previous logic of leaving pensions untouched.

4. Renewed Interest in Annuities. Converting a pension pot into a guaranteed income through annuities could help reduce the value of unused funds at death and potentially lower IHT liability.

Planning ahead, what clients should be doing now

With nearly two years until the change comes into effect, there’s time to plan. Clients should be encouraged to:

• Review their estate plans, particularly how pensions fit into their broader strategy;

• Seek professional advice including options like gifting, restructuring assets, or rebalancing drawdown strategies; and

• Stay informed as further detail from HMRC emerges - keeping abreast of technical updates will be key.

By addressing these changes early, individuals can better safeguard their estate and ensure their beneficiaries receive what was intended, with minimal tax leakage.

This shift turns traditional estate planning on its head – early advice is key to protecting your wealth

Here to Help

A sensible first step is to review your own financial arrangements, or those of your clients, under the current legislation and consider how things might change from 2027. From there, it’s worth developing a contingency plan to mitigate any potential inheritance tax impact once the new rules come into effect.

At Law Society (NI) Financial Advice, we’ve supported solicitors, their families, and their clients for over 30 years. Whether you’re reviewing your own position or advising others, our team can provide expert, independent guidance to help you navigate the options.

To speak to one of our advisers, call 028 9023 0696 or email info@lsnifa.com

Law Society (NI) Financial Advice Limited is authorised and regulated by the Financial Conduct Authority. FCA registered number 141726. Law Society (NI) Financial Advice Limited is registered in Northern Ireland with company number NI23143. Registered office is located at 42-44 Rosemary Street, Belfast, Northern Ireland, BT1 1QE. The Financial Conduct Authority does not regulate advice on taxation or estate planning. This content is for general information only and does not constitute advice. The information is aimed at retail clients only. This information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation, are subject to change.The content was accurate at the time of writing, changes in circumstances, regulation and legislation after the time of publication may impact on the accuracy of the article.

The combination of IHT and income tax could see beneficiaries lose up to 67% of inherited pension wealth