A significant overhaul of inheritance tax (IHT) rules is set to take effect from April 2027, bringing most unused pension funds into the scope of IHT. This marks a notable departure from historical precedents where many pension pots were exempt from the tax, often serving as a key mechanism for intergenerational wealth transfer. The reforms, initially outlined in the 2024 Autumn Budget by then-Chancellor Rachel Reeves, mean that individuals passing on substantial pension wealth will need to consider the potential tax implications for their beneficiaries.
From 6 April 2027, personal and occupational defined contribution (money purchase) pension funds, inherited pension funds in drawdown, and pension funds paid into a trust on death will all be liable for IHT if the total estate value exceeds the nil-rate band of £325,000. Additionally, guaranteed payment period income or value protection lump sums from annuities, and defined benefit (final salary) lump sum death benefits, will also be included. This shift is projected to impact over 10,000 additional estates in the 2027/28 tax year alone, according to government estimates.
However, the new regulations are not universal, and several key exemptions will remain. Death in service benefits, whether linked to defined contribution or defined benefit schemes, will continue to be exempt from IHT. Dependants' scheme pensions, which provide a regular income to a surviving spouse, civil partner, child, or financially dependent individual, will also remain outside the IHT net. Furthermore, trivial commutation lump sums from inherited dependants' schemes, provided they are under £30,000, and joint-life annuities that pay out to a survivor, will not incur IHT.
Further relief is provided for death benefits transferred to a UK long-term resident spouse or civil partner, or directly to a charity, as these will also be exempt from IHT. Crucially, the State Pension is entirely unaffected by these changes and will not form part of an estate for IHT purposes. These nuances highlight the need for careful planning, as individuals and families navigate the complexities of their retirement and estate provisions ahead of the 2027 implementation.
Gary Smith, senior client partner at wealth manager Evelyn Partners, noted that the rule change will significantly influence how individuals manage their pension spending in retirement, and will add complexity to will drafting and broader estate planning. While the headline suggests a sweeping inclusion of all pensions, understanding the specific exemptions and inclusions will be vital for UK households looking to optimise their financial arrangements for future generations.