The End of the Pension IHT Loophole: What Families Must Know About Inheritance Tax on Pensions
The rules on inheritance tax on pensions are changing. From April 2027, most unused pension funds will form part of a deceased person’s estate for inheritance tax (IHT) purposes. For many families, this is a significant shift. For decades, pensions sat outside the estate and passed on free of IHT. That is about to end.
We set out what the changes mean, who they affect, and what families and executors should understand now.
Why pensions were tax-free to pass on
Under the current rules, defined contribution pension funds, the type where you build up a pot of money, do not count as part of your estate when you die. That means they fall outside the scope of IHT entirely.
As a result, many people used their pension as a deliberate estate planning tool. They drew down on other savings first and left the pension untouched, passing it to children or grandchildren free of the 40% IHT charge. Financial advisers widely recommended this approach.
The government has decided that arrangement is too generous. The Chancellor announced the change in the Autumn 2024 Budget, and it is now law. The Finance Act 2026 received Royal Assent on 18 March 2026 and amends the Inheritance Tax Act 1984 so that most unused pension funds and death benefits fall within the estate for deaths on or after 6 April 2027.
Some detail still sits in secondary legislation, mainly the information sharing rules between executors and pension schemes, which HMRC expects to lay later this year.
What the new rules on inheritance tax on pensions will mean
From April 2027, the value of unused pension funds will be added to the rest of the deceased’s estate. The combined total will then be assessed against the nil-rate band (the amount you can leave before IHT applies, currently £325,000) and the residence nil-rate band (an additional allowance of up to £175,000 where a home passes to direct descendants). Both allowances are frozen: the nil-rate band at £325,000 until April 2031, and the residence nil-rate band at £175,000 until April 2031. As estates grow and the thresholds stand still, more families are drawn into the net each year.
Anything above those thresholds will, in most cases, face a 40% IHT charge.
For many families, this will push estates above the IHT threshold for the first time. A person with a £300,000 house and £100,000 in savings, for example, has an estate of £400,000, comfortably within the combined allowances. Add a £200,000 pension pot and the estate becomes £600,000, leaving roughly £100,000 exposed to inheritance tax that would previously have passed on tax-free.
Who is not affected: the spouse and charity exemptions
The existing exemptions survive. Pension funds and death benefits passing to a surviving spouse or civil partner remain free of inheritance tax, provided they are a long-term UK resident. The same applies to anything passing to a registered charity. Death in service benefits paid from a registered pension scheme also stay outside the scope of inheritance tax.
For most married couples, then, nothing changes on the first death. The issue arises on the second death, when the combined estate passes to children or other beneficiaries.
Who is most affected by this change
The change hits hardest those who have spent years treating their pension as a tax-efficient inheritance vehicle. These are, broadly speaking:
- People with substantial defined contribution pension pots who have other sources of retirement income
- Higher earners who have maximised pension contributions over a long career
- Those whose estates, when the pension is added, will cross the nil-rate band threshold
Defined benefit pensions, the older “final salary” type, work differently and the position on those is more complex. Anyone with a defined benefit pension should speak to a qualified financial adviser to understand their specific position.
The interaction with probate and inheritance tax
The changes also affect how estates are administered after someone dies, and this is where the biggest practical shift lies.
Under the original 2024 proposal, pension scheme administrators would have reported and paid the tax. That was reversed. Personal representatives, meaning the executors or administrators of the estate, are now responsible for reporting and paying any inheritance tax due on unused pension funds. It is a significant burden: executors become liable for tax on assets they do not control, may not know about at the outset, and cannot access directly.
To make that workable, pension schemes have new supporting duties. An executor, or someone who expects to be appointed executor, can instruct a scheme to withhold 50% of the benefit entitlement for up to 15 months after the end of the month in which the person died. Executors or beneficiaries can also instruct the scheme to pay the inheritance tax straight to HMRC under the new Pensions Direct Payment Scheme.
Timing matters. Interest runs on unpaid inheritance tax after six months, and penalties can apply from 12 months after death. Executors will also need to approach pension schemes before the grant is issued, which means proving their identity and entitlement without a grant of probate in hand. In some cases the IHT liability could be substantial, and the executor will need to understand how and when it must be paid before probate is granted.
What families should do now, before April 2027
The change does not come into force until April 2027. That leaves time to review existing arrangements, though it does not leave unlimited time.
Those with large pension pots should speak to an FCA-regulated financial adviser now. There may be options worth considering, including drawing down pension funds earlier, gifting assets within the seven-year rule (where gifts made more than seven years before death are generally exempt from IHT), or restructuring other assets to make better use of available allowances.
However, the options are individual-specific. What suits one person’s estate may not suit another’s. General guidance is a starting point; professional advice is essential for anyone materially affected.
A note for executors
If you are administering an estate now, under the current rules, unspent pensions generally remain outside the taxable estate. However, executors dealing with deaths from April 2027 onwards will need to factor pension values in from the outset.
Keep records of all pension arrangements held by the deceased. Contact pension providers early in the administration process. Where the estate is large or complex, instruct a probate solicitor from the beginning.
FAQs: Inheritance tax on pensions
Q: Will inheritance tax apply to all pensions from April 2027?
A: The changes apply to most unused pension funds and death benefits, with defined contribution pots the clearest case. The treatment of defined benefit schemes is more complex and depends on the form the benefit takes. Check the position on your specific pension with a qualified financial adviser or your scheme.
Q: Does the new rule mean my entire pension will be taxed at 40%?
A: Not necessarily. The pension value is added to the rest of the estate and the combined total is assessed against the nil-rate band and, where applicable, the residence nil-rate band. IHT at 40% applies only to the amount above those thresholds. If the total estate, including the pension, remains below the available thresholds, no IHT will be due.
Q: Can I avoid the new inheritance tax on pensions by withdrawing my pension before I die?
A: Withdrawing pension funds means they become part of your income and assets, and so they may still form part of your estate. In addition, large withdrawals could trigger income tax at your marginal rate. This is a decision that needs careful consideration with an FCA-regulated financial adviser, not a step to take without professional input.
Q: What does this mean for the probate process when someone dies after April 2027?
A: Executors will need to obtain the value of any unused pension funds and include that figure in the estate valuation for IHT purposes. Responsibility for reporting and paying the tax sits with the executors, not the pension provider, so gathering this information early matters. Where the pension pushes the estate above the IHT threshold, the executor will need to arrange payment of the tax due before probate is granted, and can ask the scheme to withhold funds or pay HMRC direct to help with that. A probate solicitor can help manage this process.
This article is for general guidance only and does not constitute legal, tax or financial advice. Rules and thresholds can change and every estate is different. For advice on your own circumstances, speak to a qualified professional. You can book a free legal consultation or speak to an FCA-regulated financial adviser through The Probate Network.