How Inheritance Tax Prompted the Great Pensions Rethink

With the rules changing next year, savers need to reconsider what they do with their pension funds.

Changes to the UK inheritance tax (IHT) rules mean, from April 2027, planning for your legacy can no longer be something left for later, you may even mean need to rethink what you put into your pension while you are saving for it.

The November 2024 Budget brought pensions back within the scope of IHT. Pensions had previously fallen within the scope of this levy before former chancellor George Osborne introduced an exemption in 2015, creating a tax loophole through which those with means have jumped with both feet.

For those who have saved too well and have an estate above the £325,000 threshold, unused pensions will receive a 40% IHT hit. That means children or any other beneficiaries of the estate other than spouses or civil partners, will not get as much as they had hoped. It gets worse. In certain cases, any funds withdrawn from the excess pension assets are then taxed as income, raising the rate further.

While most people in the UK will not have an estate large enough to be affected by the IHT change, it definitely boosts the number of pension holders affected. Data from a HMRC policy paper, calculates that, every year from 2027, nearly 50,000 people will either pay some or more IHT than previously. This broader reach will rope in those people not tax resident in the UK but with UK-based pensions.

What this means is retirees will need to rethink their saving strategies at a much earlier stage. Just pouring money into a pension and then leaving it will no longer work if you want to maximise your legacy.

There is consideration that should be given to categorise some of your capital as ‘red money’, those funds seen as very much surplus to your needs. This pool of money would eventually pass on to your descendants, or other beneficiaries, after death. Saving beyond what you need is falling out of favour for IHT reasons and any surplus needs a plan. Using pensions as a repository for that ‘red money’ will make less tax sense for some retirees.

Acting sooner with IHT gives you the most flexibility and you will also need to factor money needed for end-of-life IHT budgeting purposes, in particular care. This will see a significant role in cash flow modelling requirements for a lot more clients!

Planning involves asking harder questions than: how much cash will you need when you retire? The biggest issue with pensions is that the tax rate will be high for anyone’s inheritance. If a person dies after 75, then beneficiaries need to pay income tax at their normal rate after IHT has been deducted. For every £100 of pension, IHT could eat up £40, but income tax on what is left could swallow £67 altogether.

In the past, the rule of leaving everything in your pension applied, but not anymore.

So, what can you do to avoid IHT that does not involve lots of specialist financial investments such as trusts?

Firstly, try spending your money. Lean into your pension savings and enjoy life, remembering, of course, about the cost of care later in life. Another way to burn through money is to gift from surplus income before retirement.

The regular giving from income exemption is something that has been underused in the past but is increasingly being asked about with inheritance tax applying to pensions from 2027. In theory, you can give away as much as you like using this exemption.

Gifting comes with a few conditions. In the first place, anything you give away must be from income. That might be salary or income from a pension but cannot be from capital. Secondly, your gift must be regular, perhaps monthly or annually and finally, money you give away should not reduce your standard of living.

Should this process not work, there is the fallback of using trusts, which removes the relevant assets from the taxable estate provided the client survives over seven years after adding the assets.

Another method involves whole-of-life insurance policies written into trusts. These pay out when the policyholder dies. The average size of these policies jumped in value by nearly 52% in 2025 over the previous year to £194,431.

One common thread runs through all the advice on IHT: do not put it off. The obvious planning steps apply. Organise the client’s Will and wishes (EoW) for their pensions and make sure all documents are organised as clearly as possible.

‍How can Prosperis help?

We are already seeing a shift in how clients are accessing their pensions in retirement.  There are plenty of other considerations too, such as who are the beneficiaries and personal representatives of the estate; what is the liquidity position of the pension assets – particularly property.  The list is not exhaustive and there are many that felt immune from IHT now caught up.

If you have questions, please contact your Prosperis adviser on 01423 223640 or at advice@prosperis.co.uk.  If you do not have an adviser we would be delighted to introduce you to one of team of experienced professionals.