Pensions and Inheritance Tax: What You Need to Know Before 2027

At Lexington Wealth, we’ve always seen pensions as more than just retirement vehicles, they’re long-term wealth builders and, until now, a highly effective way to pass assets to loved ones tax-efficiently.

But the government has announced a significant change.

From 6 April 2027, it plans that most unused pension funds will be drawn into your estate for inheritance tax (IHT) purposes. If your estate exceeds the available nil-rate band (£325,000), those pension funds could face a 40% tax charge, before income tax is even considered.

Here’s what you need to know and how we’re helping clients plan ahead.

What’s Changing with Inheritance Tax and Pensions?

Currently, most pension death benefits sit outside your estate. That means:

• No inheritance tax.
• Beneficiaries only pay income tax (if applicable) when drawing funds (if pension holder is over 75 when died).
• If death occurs before age 75 and funds are paid as income, there’s no tax at all.

From 6 April 2027, the plan is this will change. Most pension pots will be included within your estate for IHT, unless:

• They are paid to your spouse or civil partner (the spousal exemption still applies).
• They fall under certain exemptions (e.g. charitable lump sums, dependant scheme pensions).

For many, this marks a fundamental shift in how pensions can be used in estate planning.

How Could This Affect You?

Let’s use an example:

Helen, age 73, has £700,000 in her pension and £800,000 in other assets. Under current rules, her pension isn’t part of her estate for IHT.

From April 2027, if she passes away and the pension is inherited by someone other than a spouse, the entire £1.5 million would be considered for IHT.

That could result in over £219,000 of tax being deducted from the pension pot, plus income tax for the beneficiary.

Depending on who inherits the funds, this could lead to effective tax rates between 52% and 67%. That’s a far cry from the current zero.

What Should You Do?

There’s no need for urgent action, and we’re here to guide you with calm, sensible planning.

But we do recommend reviewing your plans if:

• You have a large pension fund you’re unlikely to spend.
• You are over age 75, or expect to live well beyond that.
• You intended to leave your pension to children or grandchildren.

Smart Moves to Consider

We’re working with clients to explore options such as:

• Taking income earlier – Yes, it’s taxable now, but could reduce the IHT exposure on death.
• Buying Lump Sum Insurance – If the income taken is not required, it could be used to purchase a tax-free lump sum payable into trust.
• Making regular gifts from income – If done properly, these gifts can be IHT-free and leave a legacy today, not just in the future.
• Diversifying legacy assets – Using ISAs, investment accounts or trusts to pass on wealth outside of pensions may make sense for some.

The key is balance. Every client’s plan is different—and that’s exactly how it should be.

Planning Ahead with Lexington Wealth

These changes don’t come into effect until April 2027, and we’ll be keeping a close eye on the final legislation. In the meantime, we’re already incorporating these updates into our planning conversations with clients.

If you’re concerned about the impact of inheritance tax on your pension, or you’d simply like to sense-check your estate plans, please get in touch.

At Lexington, our role is to help you make smart decisions, guided by the latest legislation, backed by robust technical knowledge, and always tailored to your life and goals.

Warren Shute MSc. CFP
Chartered Financial Planner
Lexington Wealth Management