Pensions have long been promoted as one of the most tax-efficient ways to save for retirement and pass on wealth.
But from April 2027, that advantage will vanish. Under new rules, pensions will be treated as part of your estate for Inheritance Tax (IHT), potentially attracting a 40% tax charge.
Combined with income tax on withdrawals and other threshold losses, the total tax burden on your pension could reach as high as 87%.
(Read Time: Approx. 4 minutes)
Topics Discussed:
- How pensions could become a major Inheritance Tax (IHT) liability from April 2027
- Practical steps to reduce your pension’s impact on your estate’s IHT burden
Understanding the 2027 Changes to Pension IHT
Currently, pensions left unused at death can usually pass to beneficiaries free of IHT, and in some cases, free of income tax.
From 6 April 2027, pension pots will be treated like other assets in your estate and assessed for IHT1. The relevant legislation will also affect:
- Uncrystallised funds (those not yet drawn from)
- Drawdown funds still held in the pension wrapper
- Lump sum death benefits
While spousal exemptions and some trusts might still apply, the default assumption is that pensions will no longer be outside of the IHT net.
This shift will impact estate planning strategies across the board. If you’ve relied on pensions as a primary inheritance vehicle, you’ll need to act fast.
How the 87% Tax Trap Happens
Let’s break down how this painful tax trap can arise under the post-2027 rules.
Imagine your total estate is already worth £2 million, including your home and investments.
You also have a £100,000 pension pot.
Before April 2027, this pension would usually fall outside your estate for Inheritance Tax (IHT).
But from April 2027, that changes, and it will count towards your estate value.
Adding the £100,000 pension now takes your total estate to £2.1 million. That £100,000 “tip over” has a ripple effect across multiple taxes:
- Inheritance Tax (IHT) on the pension
Once the pension is pulled into your estate, it becomes taxable at 40%.- £100,000 × 40% = £40,000 IHT
- Loss of the Residence Nil Rate Band (RNRB)
The RNRB of £175,000 starts tapering once your estate exceeds £2 million, at £1 lost for every £2 over the threshold.- Your estate is £100,000 over, so you lose £50,000 of RNRB:
- £50,000 × 40% = £20,000 extra IHT
- Income Tax on pension drawdown
When your beneficiaries (who are higher-rate taxpayers) withdraw the inherited pension, they’ll pay income tax at 45% on what they receive:- £60,000 × 45% = £27,000 income tax
Total Tax Hit
| Tax type | Amount | Calculation |
| Inheritance Tax (on pension) | £40,000 | £100,000 × 40% (IHT) |
| Loss of Residence Nil Rate Band | £20,000 | £50,000 lost × 40% (IHT) |
| Income Tax (for beneficiary) | £27,000 | £60,000 taxed at 45% (Income Tax) |
| Total tax | £87,000 | — |
That means out of a £100,000 pension, only about £13,000 ultimately reaches your loved ones, an effective 87% tax rate.
This scenario highlights how even a modest pension can trigger heavy taxation once an estate crosses the £2 million mark.
For families in areas where property prices already push close to that level, it’s an early warning to plan ahead before April 2027.
Key Steps You Should Take Now
The good news is there are still options to mitigate the damage. Here’s what you should consider:
Take Your Tax-Free Lump Sum Early
Most pensions allow for 25% of the pot to be drawn tax-free.
Taking this earlier rather than letting it accumulate within your estate can reduce your IHT exposure.
This gives you the chance to spend or gift it while alive, which means it’s no longer part of your estate, reducing the value.
Check for Spousal Exemptions
Ensure your pension provider has spousal exemptions properly written into the policy.
This allows the pension to pass to your spouse on death without incurring IHT.
Many people assume this is automatic, but it isn’t.
Review Your Will and Pension Nomination Together
Your pension nomination (the form you submit to your provider) should mirror the intentions in your Will.
A mismatch could result in delays, confusion, or worse, unintended tax consequences.
Don’t Let Your Pension Pot Grow Blindly
If you’re of an age where pension withdrawals are possible, and your estate value is nearing or exceeding the £2 million threshold, consider drawing from your pension sooner to reduce the value exposed to tax.
Align with Your Pension Adviser and Tax Planner
This isn’t a change you can afford to overlook.
Speak to a qualified pension adviser and a tax planning specialist to reconfigure your estate strategy.
There may be ways to redirect assets, use trusts, or even restructure your pension for better efficiency.
Summary
The 2027 reform to pension tax rules represents one of the most significant shifts in estate planning in recent years.
What was once a tax-efficient legacy tool may now become a costly IHT liability.
For high earners and homeowners, especially those approaching retirement, the stakes are enormous.
The time to act is now.
If you’re unsure how the new rules will affect your family’s inheritance or want to make sure your pension strategy is tax-efficient, get in touch with us at Tax Expert.
Fill out our form here for any questions, email us at info@taxexpert.co.uk, or message us on our WhatsApp for out of office hours.
Kind regards,
Ilyas Patel
