Inheritance Tax on pensions 2027: the new “double tax” trap

For years, there has been a quiet rule of thumb among successful professionals and business owners: if you don’t need your pension for income, leave it alone and pass it to the children.

That approach has worked because pensions have acted as a tax shelter. In many cases, wealth held inside a pension has been able to pass outside your estate for Inheritance Tax (IHT) purposes.

However, the landscape for Inheritance Tax on pensions 2027 is shifting dramatically. Under current government policy, most unused pension funds and death benefits will be brought into the value of your estate for IHT.

And the real sting is this: it isn’t just a new 40% charge. It is the way IHT can interact with Income Tax when your beneficiaries draw the pension. That is where the “double tax trap” comes from.

If you have spent years building a pension, this matters.

What changes for Inheritance Tax on pensions 2027?

At the moment, the rules around pension death benefits can be very generous, especially if you die before the age of 75.

From 6th April 2027, most unused pension funds and death benefits will be counted as part of your estate for IHT purposes. That means your pension is no longer automatically “outside” your estate when HMRC calculates whether IHT is due.

There is another practical point here: personal representatives (usually your executors) are expected to be responsible for reporting and paying any IHT due on those pension amounts.

The maths: how the “double tax” trap works

Below is the basic “double tax” mechanism, using a simple £100,000 pension example.

Step 1 – Inheritance Tax

You die leaving a £100,000 defined contribution pension pot (SIPP/workplace DC) that is payable to your adult child. If that pension is now counted as part of your estate, and your estate is already above the available thresholds, IHT at 40% can apply.

Step 2 – Income Tax

Your beneficiary then draws money from the inherited pension. Because pension withdrawals are treated as income, they may have to pay Income Tax on the amount remaining after IHT has been deducted.

Here is how that looks for a beneficiary who is an Additional Rate (45%) taxpayer:

The Result

Your family keeps just £33,000 of the original £100,000. That is an effective tax rate of 67% – nearly 70p in every pound has gone.

That is why we are drawing your attention to this now. The pension “tax shelter” has been a mainstay of estate planning for many years. Before it is removed in April 2027, it’s a sound plan to revisit your estate planning.

Why this can hit harder than you expect

There is a secondary effect people often miss: bringing pensions into your estate can push you over thresholds that affect other allowances.

For example, the Residence Nil Rate Band starts to taper off once your estate is valued over £2 million (it reduces by £1 for every £2 above the threshold).

If your estate was already close to £2m, adding pension wealth could shrink the allowances available to your family. It is one reason a “simple” pension change can result in a larger IHT bill than you first assume.

Does the spousal exemption still help?

Yes, in many cases. Transfers to a spouse or civil partner remain outside IHT in the usual way. Policy notes indicate the spousal and charity exemptions will be maintained for these pension changes.

But there is an uncomfortable truth – this can simply delay the problem.

If your pension passes to your spouse and they don’t use it either, then on the second death the pension may still be sitting there as a large, tempting target.

So the question becomes: are you protecting your spouse? Or are you just parking a tax bomb for your children?

The death in service and group life confusion

If you are employed and you have a death-in-service benefit through work, don’t assume this change automatically means your family will lose a large chunk of it to IHT.

Government guidance has confirmed that death-in-service benefits payable from registered pension schemes are intended to be out of scope of IHT from 6th April 2027, including where the scheme is discretionary or non-discretionary.

This change is aimed primarily at private pension wealth used as an estate planning vehicle, not at making ordinary workplace protection benefits unusable.

(That said, benefit structures vary. If you are relying on workplace benefits as part of your wider plan, it;s worth checking your paperwork.)

Three strategies to protect your family

There isn’t a one-size-fits-all answer. But there are three broad approaches we are discussing with our IHT planning clients now.

1. Lifestyle financial planning – spend the pension to protect other assets

If you have been “stuffing the pension” and living off ISAs, dividends or rental income, this flips the logic. You may want to draw pension income deliberately (accepting Income Tax on the way out), and use that income to fund living costs so you can:

• Preserve non-pension assets for gifting
• Gift assets earlier to start the clock on the 7-year rule
• Reduce the taxable value of the estate over time.

In the right circumstances, you can also use the normal expenditure out of income exemption to gift regular amounts from surplus income, provided the gifts are genuinely from income and don’t reduce your standard of living (records matter). This can be a powerful tool when done properly.

Read more: How to use the Gifts Out of Surplus Income exemption >

2. Skipping a generation

You may hear people say: “Just nominate the kids, not the spouse.”

This can be sensible in some situations because it may reduce how much wealth is exposed to IHT on the second death. But it can also create problems. For example, it may leave your spouse short of options later, or it could backfire if your estate is near allowance taper thresholds.

So, if you’re thinking about changing your Expression of Wish or nominations, be sure to get professional advice and do it as part of a joined-up plan.

3. Life insurance to cover the bill

If you expect an IHT bill and don’t want your family forced into rushed decisions, life insurance could provide liquidity when it is needed.

A common planning route is a policy written in trust. This means the proceeds can sit outside the estate and be available to meet the tax bill. This helps make sure that your beneficiaries aren’t forced to dismantle your retirement and investment plan simply to pay HMRC on time.

Inheritance Tax on pensions 2027 deadline is getting closer

While 6th April 2027 sounds a long way off, effective estate planning nearly always takes longer than people expect. For example, you may need time to:

• Investigate outcomes for different beneficiaries and tax rates
• Update your Will and executors’ instructions
• Review pension nominations and family objectives
• Plan gifting properly (and document it)
• Put insurance and trusts in place where appropriate.

The key point is simple: don’t let HMRC become your main beneficiary!

If you want to review your current plan in the light of the Inheritance Tax on pensions 2027 rules, we can help you run the numbers and build a practical strategy around your pension, your Will and your wider estate.

Book a pre-2027 wealth protection review

If you have a substantial defined contribution pension you were intending to pass to your children, now is the time to act.

Book a Wealth Protection Review with THP and we will help you restructure your plan around the scheduled 2027 pension IHT changes – including your Will, your pension nominations and your gifting strategy.