Pension reforms proposed for 2027 What you should know...

Owing to these features, pensions have become a widely used and effective tool for intergenerational wealth transfer. Many individuals have chosen to preserve their pension funds while drawing income from other assets, knowing that pensions currently sit outside the estate for IHT purposes.

What will change in April 2027?

The government’s proposed reform will bring some pension savings back into the IHT net. Specifically, the unused value of defined contribution pensions at the time of death will, from April 2027, be treated as part of the deceased’s estate. This means they may be subject to the standard 40% inheritance tax rate where applicable.[3]

This change is particularly significant for individuals who die after the age of 75. Under current rules, beneficiaries of these pensions are already required to pay income tax on any withdrawals at their marginal rate. Under the proposed reform, they may now also face IHT on the value of the unused pension pot. In effect, this amounts to double taxation.

For higher rate taxpayers, the combined tax burden could be substantial. A beneficiary paying 45% income tax could face an effective tax rate of up to 67% on pension withdrawals. In cases where large withdrawals push someone into a higher tax band, the overall tax liability could increase even further. For wealthier estates, the tapering of the residence nil-rate band (where it is gradually removed for estates worth over £2 million) could push the effective tax rate to around as much as 70%.[4]

Initial concerns over the complexity of the original proposals, particularly regarding potential delays in estate administration, appear to have been partly addressed. Under the revised draft, the responsibility for reporting and settling IHT on pension death benefits will shift from scheme administrators to the deceased’s personal representatives. However, ambiguity remains around how schemes will practically facilitate IHT payments to HMRC, with some administrative processes still to be clarified.

Importantly, the government confirmed that all death in services schemes, regardless of how they’ve been provided, will not be subject to IHT.

According to the government, these changes are aimed at closing perceived loopholes and promoting fairness across asset classes. It is important to note that these reforms remain in draft form and are subject to potential amendments before being enacted.

Wider pension reforms on the horizon

These inheritance tax related changes are part of a broader set of pension reforms included in the government’s draft Pension Schemes Bill.[5] Other potential changes expected between 2027 and 2030 include:

• The introduction of value-for-money assessments across workplace schemes, intended to improve transparency and performance for savers.
• The consolidation of small pension pots to reduce administrative inefficiencies and lost accounts.
• A requirement for pension schemes to provide default decumulation pathways to help retirees manage income sustainably.
• Greater investment in UK assets through pension funds, as part of a wider initiative to support domestic growth.

While these broader reforms are primarily aimed at improving outcomes for the average pension saver, the IHT proposal is particularly relevant for high net worth individuals who use pensions as part of their estate planning.

Who might be impacted?

The changes are not expected to affect all pension savers equally. The most significant impact would be felt by individuals with large defined contribution pension pots that are unlikely to be fully drawn upon during their lifetime.

To put this into perspective, under the current rules, the nil-rate band, the portion of an estate that is not subject to IHT, is £325,000 per individual, or £650,000 for a couple (if none of the £325,000 was used when the first partner of the couple died).[6] In addition, many estates may benefit from the residence nil-rate band, which can add up to £175,000 per person when passing a main residence to direct descendants, taking the total potential exemption to £500,000 per person or £1 million per couple.[7]

When unused pension funds are brought within the estate for IHT purposes, individuals whose total estate value, including their pension pot, exceeds these thresholds would be affected. For example, an individual with £900,000 in non-pension assets and a £600,000 pension fund would previously have had only the £900,000 considered for IHT. Now, with pensions included, their entire £1.5 million estate would be subject to IHT, significantly increasing their potential tax liability.

According to HMRC estimates (prior to the draft legislation), approximately 10,500 estates could face an IHT charge on pension funds for the first time, while around 38,500 estates that already pay IHT might see their liability increase.¹

For many retirees who use their pensions to fund retirement and gradually draw down their pot, there may be little to no change (as IHT would only apply to the unused portion remaining at death). That said, for those who are preserving their pension wealth as a legacy asset, this change will alter the tax efficiency of their approach.

Impact on estate planning

While nothing will change until 2027, speaking to your financial adviser now to explore how your current plans will be affected is recommended. Strategies worth discussing could include:

• Reviewing the balance between pension and non-pension assets in your estate.
• Assessing whether it may be appropriate to draw more from pension savings earlier in retirement, particularly if other assets are already IHT-efficient (e.g., AIM shares or trusts).
• Evaluating whether gifting strategies, such as gifting out of excess income, or trust arrangements could play a more prominent role in your long term planning.
• Exploring wider estate planning strategies, where alternative tax-efficient investments, such as offshore bonds, may be considered. Offshore bonds can offer flexibility, allowing you to assign policy segments to beneficiaries over time. This can gradually reduce the value of your estate for inheritance tax purposes, although gifts may be subject to the seven-year rule and other tax considerations.
• Ensuring that your pension nomination forms and will are up to date and structured to reflect any future tax landscape.
• It may also be worth modelling different estate scenarios under both the current and draft rules to understand potential tax exposures and opportunities for mitigation.

What should you do now?

Ultimately, nothing has changed yet and won’t until April 2027. As such, there is no immediate need to act, and any planning changes you make now should be made with care and professional advice. That said, early awareness is valuable. If you are likely to be affected by these reforms, it is strongly encouraged you speak to a financial adviser. Beginning the process of reviewing your pension strategy now, within the context of your wider financial plan, can ensure you’re well prepared to respond confidently when the reforms take effect.

This is also an opportune time to speak with close family members, particularly those who may act as your lasting power of attorney (LPA) or be involved in managing your affairs later in life. Ensuring they understand your intentions and the implications of these changes can help avoid confusion and support more informed decisions.

Being prepared does not mean acting prematurely, but it does mean thinking ahead.

Moving forward

The draft 2027 pension reforms serve as a timely reminder that tax legislation is always evolving. For many, pensions have been a central element of tax-efficient wealth transfer, and any change to that status quo can have material consequences. While there is no need for immediate action, being informed and prepared is key. As always, we recommend working with your financial adviser to ensure your strategy remains aligned with your long term goals and ready to adapt.

The Financial Conduct Authority does not regulate Tax, Trust & Estate Planning, Will-writing or Cashflow modelling.