Pensions and inheritance tax — why they're so valuable for estates.
Under current rules, DC pensions sit outside the estate for inheritance tax. That single fact makes them one of the most powerful tax-planning assets available. Here's why, what's proposed to change from April 2027, and how sequencing withdrawals can protect more of an estate.
- ▸DC pensions are currently outside the estate for inheritance tax purposes. A £500,000 pension pot passes to beneficiaries without triggering the 40% IHT charge — unlike property, ISAs, or cash savings.
- ▸The proposed April 2027 reform would bring unused DC pension funds into the estate for IHT. If legislated, pensions would lose their unique IHT-exempt status.
- ▸Under current rules, spending ISAs and other taxable assets before the pension — 'pension last' sequencing — can reduce the taxable estate while preserving the IHT-free pension pot.
- ▸IHT planning involves multiple interacting rules. The pension is only one part of the picture alongside property, trusts, gifts, and the nil-rate band.
- •IHT planning is complex and depends on individual circumstances including total estate value, property ownership, existing trusts, and gifts made within seven years of death. This article covers the pension element only.
- •The proposed April 2027 reform is subject to final legislation and may change before implementation. Decisions made on the basis of proposed rules carry legislative risk.
- •This article does not constitute estate planning advice. For personalised guidance, consult an FCA-regulated financial adviser and an estate planning solicitor.
Why pensions sit outside the estate (currently)
Inheritance tax applies to the value of a person's estate at death. The estate includes property, savings, investments, and most other assets. The current IHT threshold (nil-rate band) is £325,000 per person, with an additional £175,000 residence nil-rate band if a main home passes to direct descendants — giving a combined threshold of up to £500,000 per person, or £1 million for a married couple.
DC pensions — workplace pensions, SIPPs, personal pensions — are not included in this calculation. Because they are held in trust (or under scheme administrator discretion), they are not considered part of the deceased's estate. A person could have a £2 million pension pot and a £400,000 house, and only the house would count towards the IHT threshold.
This makes pensions uniquely valuable in estate terms. Every other major asset class — property, ISAs, cash, general investment accounts, premium bonds — falls within the estate. The pension is the exception.
The exception exists because the member does not have a legal right to direct where the pension goes at death. The scheme trustees exercise discretion (guided by the member's expression of wishes). That discretionary element is what keeps the pension outside the estate.
The 2027 IHT reform: what's changing
In the Autumn Budget 2024, the government announced that from April 2027, unused DC pension funds would be included in the deceased's estate for IHT purposes.
If legislated as proposed:
- The remaining DC pension pot at death would be added to the estate value for IHT calculation
- If the combined estate (including the pension) exceeds the nil-rate band, 40% IHT would apply to the excess
- Beneficiaries would still pay income tax on withdrawals from inherited pensions (for deaths after 75) — potentially creating double taxation on the same funds
The reform would not affect DB pensions (which pay a defined income, not a transferable pot) or the state pension.
The detail of how double taxation would work — or whether relief would be provided — is still subject to consultation. The pension IHT reform 2027 guide tracks the latest position.
The estate planning implications before and after 2027
Under current rules (pre-April 2027):
A pension pot is the last asset to spend in retirement if the goal is to minimise the estate's IHT exposure. Every pound left in the pension at death is a pound that avoids IHT. Every pound withdrawn and moved to a bank account or ISA enters the estate.
Example: A retiree with a £400,000 pension, £200,000 in ISAs, and a £350,000 house has a total wealth of £950,000. But for IHT, only the ISAs and house count — £550,000. With a nil-rate band of £500,000 (including residence nil-rate band), the IHT exposure is just £50,000 × 40% = £20,000. If the entire £400,000 pension had been withdrawn and sat in a bank account, the IHT exposure would be (£950,000 − £500,000) × 40% = £180,000.
Under proposed rules (post-April 2027):
The same retiree's pension would count towards the estate. Total estate for IHT: £950,000. IHT exposure: (£950,000 − £500,000) × 40% = £180,000. The pension's IHT advantage disappears.
If the reform proceeds, the incentive to preserve the pension pot for IHT purposes would be significantly reduced — though the pension may still offer advantages through income tax-free growth and the before-75 income tax exemption.
Spending from ISAs first: the sequencing strategy
Under current rules, the order in which retirement assets are spent matters for IHT:
- Spend taxable and ISA savings first — these are in the estate anyway. Using them reduces the estate.
- Preserve the pension pot — it sits outside the estate and passes tax-free (before 75) or income-tax-only (after 75).
- Use the pension last — draw from it only when other sources are exhausted, or when the income tax cost of pension withdrawals is lower than the IHT saving.
This sequencing is rational under current rules but is not without trade-offs. Depleting ISAs and cash early reduces liquidity and flexibility. And if the 2027 reform proceeds, the IHT benefit of preserving the pension pot may no longer apply.
The pension drawdown calculator can model withdrawal sequences, and the pension inheritance calculator shows the impact on what beneficiaries receive.
- ▸DC pensions are currently held in trust and sit outside the estate for IHT purposes. Beneficiaries receive the pot without a 40% IHT charge. [HMRC]
- ▸The IHT nil-rate band is £325,000 per person. The residence nil-rate band adds up to £175,000 when a main home passes to direct descendants. [GOV.UK]
- ▸In the Autumn Budget 2024, the government announced that unused DC pension funds would be brought into the estate for IHT from April 2027, subject to consultation and final legislation. [HM Treasury]
This is factual information, not financial advice. If you're unsure what's right for your situation, speak to an FCA-regulated financial adviser.