Pension Fund Inheritance Tax Changes 2027 Explained

If you’ve spent decades building a pension pot, the idea that it could be hit with a 40% tax bill after you’re gone is enough to make anyone sit up and take notice. From 6 April 2027, unused pension funds in the UK will no longer sit safely outside your estate for Inheritance Tax purposes — and the change applies to deaths from that date onwards. This article walks through what’s actually changing, which pension types are affected, and the practical steps you can take before the reform lands.

Effective Date: 6 April 2027 · Announcement: October 2024 Budget · Scope: Most unused pension funds · Applies To: Deaths on or after 6 April 2027 · Current Status: Pensions generally IHT-exempt

Five figures define the scope of this shift: the nil-rate band, the residence nil-rate band, the standard IHT rate, and two key withholding parameters that shape how the tax is collected.

How to avoid inheritance tax on pensions 2027

With unused pension funds joining the taxable estate, anyone with substantial DC pension savings faces a real liability — potentially £140,000 in IHT on a £350,000 excess above the nil-rate band. The strategies below focus on actions available before 6 April 2027, as well as ongoing approaches that remain relevant after the reform takes effect.

Current strategies before 2027

Acting before the reform deadline gives pension holders the widest range of options, since defined contribution pensions will still sit outside the estate for deaths before 6 April 2027. Three approaches dominate the planning conversation:

• Take lump sums now: Drawing down tax-free cash from a SIPP or workplace pension and transferring those funds into an ISA removes that money from the post-2027 IHT estate entirely. The ISA then sits outside pension legislation and passes to beneficiaries free of IHT (though it does form part of the estate for IHT purposes, unlike the pension — so timing and structure matter).
• Purchase an annuity: Converting pension savings into a lifetime annuity means the fund is depleted before death. An annuity also stops unused fund amounts from accumulating in the estate post-2027. This approach suits those who no longer need to draw flexible income.
• Review and update your will: Many pension holders overlook that death benefit nominations are separate from a will. Ensuring your scheme administrator has an up-to-date expression of wish form is critical — PRs use these nominations to distribute pension death benefits, which will now interact with IHT reporting.

The catch: each option carries trade-offs. Withdrawing pension funds early triggers income tax on any amounts above the 25% tax-free lump sum allowance, and once money leaves a pension it cannot be returned. Annuitisation removes flexibility and access to the fund. Fidelity (investment management firm) notes that spending pension assets before other savings — the inverse of the traditional approach — may now make sense to avoid a potential effective tax rate exceeding 60% on death after age 75.

Post-2027 options

Once the reform is in force, the focus shifts to legal structures and gifting strategies that reduce the taxable estate:

• Charitable giving: If a pension beneficiary is a registered UK charity, those payments remain fully exempt from IHT. Some pension holders are considering adding charitable death benefit nominations to offset IHT exposure from other pension funds.
• 7-year gifting clock: Gifts made during lifetime that survive 7 years fall outside the estate. While pension funds themselves cannot be gifted directly, other assets given away may reduce the non-pension estate, leaving more nil-rate band headroom for the pension portion.
• Bespoke trusts: Certain trust structures can hold assets outside the estate, though trust arrangements involving pension funds have historically attracted HMRC scrutiny since the policy aim is to stop pensions being used primarily as inheritance vehicles.

Are final salary pensions subject to inheritance tax

Final salary — or defined benefit (DB) — pensions operate differently from defined contribution pots, and the 2027 reform makes a clear distinction between the two.

Defined benefit vs defined contribution

DB schemes pay a guaranteed income in retirement based on salary and years of service. Because that income stops or reduces on death, there is typically little or no unused fund remaining at death — and therefore no additional IHT liability under the new rules. Nelsons Law (solicitors) confirms that defined benefit schemes are generally excluded from the IHT estate because the fund is used up funding retirement income.

The contrast with DC pensions is stark: a SIPP, personal pension, or workplace defined contribution pot can build up significant unused funds if drawdown was never taken or was taken sparingly. Those unused amounts — and any crystallised funds held as drawdown at death — now fall within the taxable estate.

Death-in-service benefits deserve special mention: lump sums paid from a workplace pension scheme when someone dies in service are explicitly excluded from the IHT changes, GOV.UK confirms. This makes employer-provided death-in-service cover less relevant as a planning tool post-2027, since the pension funds themselves now carry the exposure.

Exceptions for spouses

The reform preserves the existing exemption for pension payments to a surviving spouse or civil partner who is UK resident. These payments continue to pass completely free of IHT, regardless of the size of the fund. Nelsons Law (solicitors) and Royal London Adviser (financial adviser) both confirm this exemption is maintained.

What this means practically: if the primary pension holder dies and leaves their remaining DC pension to a surviving spouse, no IHT is due on that amount. The surviving spouse then inherits the pension and can draw from it in their own retirement — and when they in turn die, those remaining unused funds will be subject to IHT unless left to another exempt beneficiary or the rules change again.

What is the maximum lump sum I can take from my pension

For those considering drawing down pension funds before 2027, the tax-free lump sum rules set a clear ceiling — and using that allowance before the reform date is one of the most straightforward planning moves available.

Tax-free lump sum limits

UK pension rules allow up to 25% of the crystallised pension fund to be taken as a tax-free lump sum, subject to a lifetime cap. As of current rules, the maximum tax-free lump sum allowance stands at £268,275. Royal London (insurance and financial adviser) provides this figure in its detailed guide to the IHT changes.

Anyone with a pension fund significantly larger than this cap who wants to withdraw more than the 25% tax-free allowance must pay income tax on the excess at their marginal rate. For basic-rate taxpayers this is 20%, rising to 40% for higher-rate and 45% for additional-rate taxpayers. The trade-off is clear: paying income tax now to remove funds from a future IHT liability of 40% may be worthwhile, particularly for estates likely to exceed the nil-rate band.

LGPS specifics

The Local Government Pension Scheme (LGPS) — a defined benefit scheme used by millions of public sector workers — operates under different rules. LGPS benefits are based on career-average revalued earnings and do not accumulate in the same way as DC pots. Because the fund is used up funding the retirement income stream, unused LGPS benefits at death are typically small, and the scheme falls outside the IHT reform scope in the same way as other defined benefit arrangements.

Workers who have moved between the LGPS and private sector DC schemes should check whether they have preserved benefits in both — the DC portion of any combined pension will be subject to the 2027 IHT changes, while the LGPS portion generally will not.

SIPP inheritance tax 2027

Self-invested personal pensions (SIPPs) are among the arrangements most directly affected by the 2027 reform. Because SIPPs are defined contribution vehicles where the holder controls investment decisions and can build up substantial unused funds, they sit squarely in the IHT reform’s scope.

What changes for SIPPs

From 6 April 2027, unused funds held within a SIPP at death — including funds held in drawdown — will form part of the deceased’s estate for IHT purposes. Nelsons Law (solicitors) confirms this applies to most SIPPs alongside other defined contribution arrangements.

Personal Representatives will be responsible for reporting the SIPP’s value to HMRC and paying any IHT due, with the standard 6-month deadline applying. The new Pension Inheritance Tax Payments Scheme allows PRs to issue a withholding notice to the SIPP provider, requesting that up to 50% of the fund be held for up to 15 months while IHT affairs are settled. David Gray LLP (law firm) outlines the mechanics of this process.

The practical impact: SIPP holders with funds above the nil-rate band (£325,000) plus the residence nil-rate band (£175,000 if the estate qualifies) face IHT at 40% on amounts exceeding those thresholds. For a SIPP with £800,000 in unused funds and no other estate assets, the IHT liability on the excess above £325,000 would be £190,000 at 40%.

Unused funds impact

The policy specifically targets unused pension funds — meaning amounts that were not drawn down as income or used to purchase an annuity during the holder’s lifetime. For SIPP holders in drawdown who have been taking regular withdrawals, only the remaining portion at death counts as unused.

One wrinkle that David Gray LLP (law firm) flags: HMRC’s IHT clearance certificate, if obtained, discharges PRs from liability for pensions discovered after the clearance is granted. This is relevant because SIPP balances can sometimes be spread across providers, and a PR may not immediately know the full picture at death.

HMRC pension inheritance tax changes

The reforms originate from HM Treasury and are implemented through HMRC guidance and secondary legislation. Understanding who is responsible for what — and when — is essential for anyone whose estate may include significant pension wealth.

Key announcement details

The government announced at the Autumn Budget 2024 that unused pension funds would enter the IHT estate from 6 April 2027. GOV.UK (official government website) states the measure explicitly: “This measure will bring most unused pension funds and pension death benefits within the value of a person’s estate for Inheritance Tax purposes from 6 April 2027.”

A technical consultation ran from 30 October 2024 to 22 January 2025, with further refinements announced at the Autumn Budget 2025. David Gray LLP (law firm) tracks these dates as the key milestones in the policy’s development.

The government’s stated rationale is worth noting: Royal London Adviser (financial adviser) quotes the official position that “pensions are not being used for their intended purpose; to encourage saving for retirement and later life. Instead, they’re being used… as an intergenerational wealth transfer tool.” The reform is designed to change that behaviour.

Death benefits rules

Under the new framework, Personal Representatives are liable for reporting and paying IHT on unused pension funds. GOV.UK (official government website) sets out this responsibility clearly.

Key procedural changes include:

• Pension scheme administrators must report pension assets to PRs when notified of a death
• PRs can issue a withholding notice requesting scheme administrators hold up to 50% of funds for 15 months
• IHT payment deadlines remain 6 months from death, with tailored solutions available for estates holding illiquid assets
• PRs can recover IHT from pension beneficiaries if those beneficiaries differ from estate beneficiaries

Preparation steps before April 2027

The period between now and 6 April 2027 is the window for action. After that date, the estate planning calculus changes fundamentally. Three categories of preparation deserve attention.

Financial planning checklist

• Audit your pension positions: Gather statements from all SIPPs, workplace pensions, and DC group personal pensions. Identify which hold significant unused balances and which are in drawdown. Calculate how much of each fund sits above the nil-rate band headroom.
• Review beneficiary nominations: Contact each pension scheme administrator to confirm your expression of wish form is current. Nominating a UK-resident spouse or civil partner passes those funds free of IHT; adult children and other beneficiaries trigger the 40% charge.
• Calculate the tax-free lump sum headroom: Know your maximum tax-free cash position (£268,275 lifetime cap). If you have substantial unused headroom and funds above the nil-rate band, a deliberate withdrawal before April 2027 — even at the cost of income tax — may reduce the IHT exposure substantially.
• Consider ISA transfers: Moving tax-free cash from a pension to an ISA removes those funds from the post-2027 IHT estate. ISAs form part of the estate for IHT purposes but offer clearer inheritance pathways without the double-taxation risk that applies to pensions.
• Update your will: Ensure your will reflects your overall estate planning, including the pension positions. Remember that pension death benefit nominations override wills in most cases — both documents need to align.

Getting professional advice

Given the numbers involved — 213,000 estates holding inheritable pension wealth, with 10,500 newly facing IHT liability — the potential liability is significant for individual estates. Foster Denovo (financial adviser) and CAF (charities adviser) both note that professional financial advice is strongly advisable for anyone with DC pension savings above £500,000.

Estate planning solicitors can advise on will structure, trust arrangements, and the interaction between pension nominations and other estate assets. Independent financial advisers can model the tax outcomes of different withdrawal strategies and advise on annuity purchase versus drawdown decisions.

Related reading: Martin Lewis Best ISA Rates for Over 60s · Barclays Bank Near Me

The pension fund inheritance tax changes effective April 2027, as detailed in the HMRC Inheritance Tax Changes 2027 guide, bring unused DC funds like SIPPs into IHT scope while preserving spouse exemptions.

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