Inheritance tax on pensions is yet to arrive, but receipts rise again

The amount funnelled into the Treasury from inheritance tax (IHT) keeps going up. Receipts for 2025/26 tax year was £8.5bn, which is £200mn higher than the same period last year, an increase of 2.4%.

The upward march of IHT collection is the result of frozen allowances increasing the burden for those falling into the tax net. While estates have increased in value over the years, the ‘nil rate band’ – the threshold under which no IHT is payable – hasn’t budged since 2009. The additional residence nil rate band, phased in from 2017, has helped offset the relentless fiscal drag, but that too has been static since it reached £175,000 in 2020/21. That’s five years of estates gaining in value as asset prices rose, while the bands remained the same.

Unfortunately, for many ordinary families the situation is going to get worse. Not only are the nil rate bands stuck in the deep freeze until at least April 2031, but a step change to the IHT regime is fast approaching. The Office of Budget Responsibility (OBR) forecasts that IHT receipts will soar to £15bn a year by 2030 owing to pension funds forming part of an estate for inheritance tax from next tax year – on top of the frozen bands and more business and agricultural assets being captured.

How inheritance tax pension rule changes will work

Wealth held in a personal pension is currently exempt from IHT, providing a haven from IHT and allowing families a way to pass on some of their money tax-free. However, the estate planning playing field has been upended. From April 2027 pensions lose their IHT exemption, creating a sudden cliff-edge for some intergenerational transfers, and it will no doubt result in more estates tipping over the nil-rate band thresholds. 

Anyone with significant pension wealth should urgently review their planning if they haven’t already, especially if they had previously planned to leave pension assets to someone who isn’t their surviving spouse. Other beneficiaries stand to face a double whammy of income tax and inheritance tax at 40% on pension assets assuming the donor passed away over the age of 75. 

If you are younger than 75 when you die, the beneficiary can withdraw money free from income tax, and this will still be the case from next April when IHT will apply. However, if you have already reached 75 with a defined contribution pension pot – such as a SIPP – when you die, your beneficiary will pay income tax on withdrawals of income or lump sums. This would be at their highest rate of tax – basic rate (20%), higher rate (40%) or additional rate (45%). It creates the potential for a pension pot to face an effective tax burden as high as 67% if it’s left to someone other than a spouse.

How to avoid inheritance tax on pensions

The shifting IHT landscape has resulted in a notable uptick in anxiety among people I’m speaking to. With some simple planning there may still be no tax bill for an estate of a married couple is less than £1mn, but if the combined estate is greater than this – including any remaining pension pots – some further thought will be required if you wish to minimise tax. 

The sooner you think about your position and what you want to do with your legacy, the better. As time goes on, the choices available to preserve more wealth tends to narrow. Many people are choosing to accelerate pension withdrawals where it’s sensible to do so, move funds into alternative arrangements, or seek guidance or advice on gifting and trust planning to minimise the impact. For others, it’s a case of releasing the purse strings and spending a bit more.

It’s also important to prepare practically for the change. Personal representatives – the family members or professionals appointed to administer the deceased’s estate and responsible for paying inheritance tax – will be required to report and pay the IHT due on unused pension funds as they do on other assets. Under the proposed rules, they will be able to issue a notice to the pension scheme to deduct tax.

What can people do to reduce the impact?

Gifting and spending

With inheritance tax on pensions, doing nothing is no longer an option for a growing number of families. One of the simplest ways to reduce future tax is to start gifting earlier, using annual allowances and surplus income rules where possible. Helping fund the next generation’s pension or ISA contributions, or even skipping a generation to fund Junior ISAs, can be excellent intergenerational strategies. Plus, they can allow your family to benefit from the money when they need it most.

There are two simple ways in which gifts can help with IHT planning.

The first is by giving an outright gift of money. Anyone can give away £3,000 tax year free of potential IHT, and you can make any number of smaller gifts of up to £250 per person a year. Over and above the various allowance all gifts – of any size – are “potentially” exempt. Potentially because you must live for a further seven years before the gifts are fully outside your estate – one of the reasons to plan early. If you die within this time frame a sliding scale is used to calculate how much tax is due on any amount over the nil rate band. 

The second is to use the “surplus out of income” rule. You can make any number of small gifts provided they do not affect your ability to fund your lifestyle. If you have to draw on any capital from your savings and investments to help you get by, the tax man will regard the gifts as having come from your reserves. And make your estate pay tax on them. This requires good record keeping to demonstrate when the gifts were made and how they were genuinely from income you didn’t need for day-to-day spending.

For those with the means, sensible spending in retirement can also makes sense. Money sitting untouched risks becoming a tax problem later, whereas money enjoyed or passed on during your lifetime can make a meaningful difference to both you and your family

Trusts

With pensions losing their special status, trusts are back in focus for intergenerational planning, but they are not a silver bullet. They require care, foresight and professional expertise to get right. Otherwise, the cost can outweigh the benefit, or there can be a loss of flexibility for little gain.

If in doubt speak to a financial adviser

Do you have a tricky financial question to solve about inheritance tax planning or something else? Speak to a real-life financial coach, who can help you gain insights and understanding of your financial situation so you can move forwards with confidence. 

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