From shelter to liability: How pension changes are going to reshape estate planning

After engaging with this content, which carries an indicative 30 minutes of CPD, you will be able to:
• Explain how pensions are currently treated in estate planning
• Explain how the treatment of pensions in IHT planning will change after April 6 2027
• Explain how the surplus income exemption might be used to mitigate IHT on pensions after 2027

Being caught in the IHT net will add a whole layer of complexity to the management and transfer of pensions. © Dionne Gibb/dvatri

Sunir Watts and Vanina Wittenburg

The UK’s pensions landscape is undergoing a seismic shift following the October 2024 Budget announcements, the subsequent government consultation, and the response to that consultation.

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The vast majority of pensions are now being brought into the inheritance tax net, whereas historically (or at least in recent history, under rules introduced in 2014), individuals’ pensions have tended to be structured to pass outside the scope of IHT on the death of the relevant individual.

In addition to passing outside the scope of IHT, pensions currently have the advantage of passing to the nominated beneficiary or beneficiaries without the need for probate and minimal input from the personal representatives (PRs).

All of this is now set to change on April 6 2027.

The position now: pensions as a tax-efficient estate planning tool

Under the current rules, where a death benefit/lump sum is payable from a registered pension scheme (whether it is a defined benefit or defined contribution scheme), that payment falls outside the estate of the deceased’s member and is therefore not subject to IHT as long as the payment is made at the discretion of the scheme trustees.

In practice, the trustees are extremely likely to follow any guidance received by the member while they were alive, usually by way of a completed nomination form.

This meant that for most people who were able to pay substantial amounts into their pension, it made sense to do so, and then nominate beneficiaries who would not normally be exempt from IHT (for example, children and grandchildren, or indeed anyone other than a spouse, civil partner or a charity) to receive the lump sum.

Typical pension planning

A typical estate planning scheme under the current rules for a married couple with children and grandchildren would prior to the Autumn 2024 Budget have involved the following:

The estate (ie non-pension assets) being left to the surviving spouse, either outright or by way of a life interest trust (giving them entitlement to income).

The surviving spouse would be encouraged to review their own position and needs, and pass assets on to children or grandchildren as soon as possible after the first spouse’s death — particularly if there was a good chance of the spouse surviving at least three years (and thus possibly benefiting from a reduced IHT liability to the extent the total value of the gifts exceeded the nil-rate band of £325,000 due to taper relief), and ideally seven years (thus ensuring no IHT at all would be payable on those assets).

The aim would be to reduce the value of the estate of the surviving spouse as much as possible, given that any assets remaining in their estate or still comprised in a life interest trust at their date of death would be subject to IHT at that stage.

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The second spouse’s estate would ideally benefit from two nil-rate bands of £325,000 (presuming they were to survive seven years from the making of the lifetime gifts to reduce their estate), and potentially two residence nil-rate bands (if the overall chargeable estate on the second death was worth less than £2mn, and a main residence or the sale proceeds thereof was left to children or grandchildren).

The pension pot would be used mainly as a repository for any excess income up to the annual allowance (£60,000 for the 2025-26 tax year), to get the benefit of pension tax relief, up to a lifetime maximum equivalent to the lump sum and death benefit allowance (£1,073,100 for the 2025-26 tax year).

The planning would be even more attractive where the relevant individual did not need the funds in the pension pot to provide for themselves in their old age, ie the individual could fund their retirement from other assets, thus leaving the pension pot untouched.

The individual would then execute a nomination form asking the pension trustees to exercise their discretion to pay their unused pension to children or grandchildren.

No IHT would be payable on those funds, and any payments subject to income tax at the beneficiary’s marginal tax rate if the death occurred after the deceased member’s 75th birthday, or completely free of income tax if the deceased member died before their 75th birthday.

Such a scheme would minimise tax on the first death and provide maximum flexibility to reduce future IHT on a second death.

A healthy pension pot was therefore a useful tool to facilitate the transfer of wealth to the next generation free of IHT.

Changes from April 6 2027

From this date, the value of unused pensions (whether the pension trustees have discretion over the destination of the funds or not) will be included in the deceased’s estate for IHT purposes, regardless of the deceased member’s age at the date of death.

Pensions will essentially be aggregated with the personal estate in the same way that life interest trusts are now.

The IHT liability will thus be calculated on the overall value of the personal estate, pensions, and other aggregable property, and it is intended that any available nil-rate band will be allocated proportionally between these separate ‘pots’.

The initial proposals were that the responsibility for reporting the value of a pension pot to HMRC, and paying any IHT arising, would fall on pension scheme administrators (PSAs).

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In its response to the consultation, which was published on July 21 2025, the government has now confirmed that the PSAs’ responsibility will be limited to:
• Informing the PRs of the value of the death benefits for IHT purposes within 4 weeks of receiving notification of the member’s death.
• Based on the information provided by the PRs about the surviving potential beneficiaries, letting the PRs know how they have determined to distribute the death benefits, including how they are to be split as between exempt and non-exempt beneficiaries. This should allow the PRs to calculate the IHT liability and allocate it between the different pots.
• Settling the IHT due on the death benefits, either direct to HMRC or by repaying the PRs if they have settled the liability from the personal estate. This may not be necessary if the recipient of the death benefit decides they will pay the IHT themselves.
• Liaising with non-exempt beneficiaries, including to explain that IHT may be due on death benefits. It is worth noting that the rules about the recipient’s income tax liability (as set out above, depending on the deceased’s member at the age of death) remain, but any payments made towards IHT in circumstances where the deceased’s member was over 75 should not be subject to any income tax in that it is envisaged that the recipient will be able to reclaim the income tax on the amount of IHT paid on the relevant amount of death benefit.

Our experience of dealing with HMRC would suggest that obtaining such refunds is unlikely to be straightforward or quick, but it is positive that the government have at least acknowledged and proposed how they will prevent the risk of double taxation.

It is worth noting that some pensions will not be within the scope of IHT, namely dependants’ scheme pensions and death-in-service benefits (regardless of whether the scheme is discretionary or non-discretionary). The latter is an improvement to the current position, whereby death-in-service benefits that are not discretionary are subject to IHT as part of the estate.

Implications for estate planning and the transfer of assets

Existing planning schemes, such as the one outlined above, are now no longer suitable if IHT mitigation is the aim.

Industry professionals are carefully considering how clients might want to restructure their estate planning before the new rules come into force on April 6 2027.

A traditional estate planning strategy is to reduce the size of one’s estate by giving assets away. This will now apply to pensions too, given that they will become subject to IHT.

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Extracting cash from pensions is not so straightforward though, as it will require more steps than with a normal asset, which can just be passed on.

The scheme member will need to drawdown on the pension and then give cash away. It might be possible to use the surplus income exemption to make tax-efficient gifts, as long as the pension income is truly surplus to requirement.

This might well be the case for a lot of clients where they were planning on leaving their pension pots untouched until their death in any event.

The surplus income exemption is a very useful one, but the record-keeping requirements are burdensome, and calculating whether there was a surplus retrospectively can be time-consuming.

Depending on various factors, including the amount being drawn down, it is also possible that the sum of the funds withdrawn from the pension will be subject to income tax in the pensioner’s hands.

Another option might be to invest the funds in IHT-efficient vehicles. Although given that business property relief and agricultural property relief are now being restricted, the options are fewer than they used to be.

Existing nominations will certainly require some thought and should be reviewed as soon as possible.

In some cases, it might make sense to move nominations to a spouse so that the pension remains IHT free — though this will then need a subsequent strategy to get pension funds out of the surviving spouse’s estate. It might nonetheless be a good interim strategy while new solutions and IHT mitigation plans are developed.

It is also important to note that the process for passing pensions on will take longer and be much more complicated.

It will require the involvement of PRs, who are now going to have to manage relationships with the tax authorities, and the trustees of both aggregable trusts and the PSAs of pension schemes.

Presumably, it will take longer for funds to be released to a beneficiary, given that they will now need to meet their own IHT liability.

Being caught in the IHT net will add a whole layer of complexity to the management and transfer of pensions.

It will be interesting to see what strategies will be suggested, and it will be incredibly important for individuals to take thorough advice that covers not just the initial steps, but also the future consequences of those steps, given that many estate planning schemes are multi-stage and implemented over long periods of time.

Thoughtful consideration of the consequences of any given scheme will be essential, and joined-up advice from solicitors, who are not generally regulated to give financial advice, and financial advisers will almost certainly be required.