Major Shake-Up in Pension Inheritance Rules: What You Need to Know

A significant change to pension Inheritance Tax rules is on the horizon. In the Autumn Budget, Chancellor Rachel Reeves announced proposed reforms to the Inheritance Tax (IHT) treatment of pension pots.

Historically, pension savings have offered a tax-efficient means of passing on wealth. But under the new proposals, this may no longer be the case. From 6 April 2027, unused pension funds and death benefits will be treated as part of the deceased's estate, potentially subjecting them to IHT at 40%. This could dramatically alter retirement and estate planning strategies for many.

To reiterate, these are proposed changes, and we are still awaiting formal legislation to confirm the exact implementation details. However, following the Government’s response to the consultation document published on 22 July 2025, it would appear that it remains the Government’s intention to implement the proposed changes.

What Are the Proposed Changes?

Currently, discretionary defined contribution pension schemes typically sit outside the estate of the deceased and are not subject to IHT. If the pension holder dies aged 75 or older, their beneficiaries are liable for income tax on withdrawals at their marginal rate, but no IHT is due.

The proposed changes would make several key adjustments:

• All unused pension funds and death benefits will be included in the estate for IHT purposes, regardless of the member’s age at death.
• The distinction between discretionary and non-discretionary schemes will be removed.
• The combination of IHT and income tax on pension funds may lead to effective tax rates as high as 70% in some cases.

These changes would effectively end the use of pensions as a tool for tax-free wealth transfer and could significantly increase the tax burden on estates.

What Does This Mean for Pensioners and Families?

For many families, this is a game-changer. Pensions have long been a cornerstone of estate planning, particularly defined contribution schemes, thanks to their favourable tax treatment. If these changes go ahead, pensions will no longer be a shield against IHT, forcing many individuals to rethink how they structure their retirement income and pass on assets.

While there is still time before any legislation takes effect, those who may be impacted should begin exploring their options now.

Planning Opportunities to Consider

Although the proposed rules are not yet in force, there are several strategies worth considering while the current regime remains in place. It is important, however, that specific advice from your IFA and tax adviser is obtained before action is taken.

1. Withdraw the 25% Tax-Free Lump Sum

From age 55 (rising to 57 in 2028), individuals can usually withdraw 25% of their pension tax-free.

These funds can then be:

• Reinvested in tax-efficient assets,
• Gifted to family members,
• Or used to support personal lifestyle or long-term care needs.

By accessing this portion early, savers may prevent it from being pulled into their estate under the proposed rules.

2. Draw Down Income for Gifting or Expenses

Using pension drawdown to create a regular income may help reduce the size of your pension pot and therefore your taxable estate. While this income may be subject to tax, it can support:

• Gifting strategies,
• Charitable donations,
• Or other expenses that reduce your overall estate value.

This approach should be coordinated with long-term retirement income planning to ensure it remains sustainable.

3. Make Gifts Out of Surplus Income

Under current rules, regular gifts made from surplus income (after meeting your living costs) are exempt from IHT. This exemption, known as "normal expenditure out of income"

To qualify:

• The gifts must be part of a consistent pattern,
• They must be made from income, not capital,
• And you must retain sufficient income to maintain your normal lifestyle.

Acceptable income sources include pension drawdown, investment income, rental income, or dividends. Keep detailed records to support your claim if HMRC ever reviews your estate.

Next Steps

With legislation expected to be published later this year and changes taking effect from April 2027, there is still time to act. However, it's crucial to take a proactive approach now.

If you have significant pension savings and had planned to use them as part of your estate strategy, now is the time to:

• Review your current estate and retirement plans,
• Consider whether withdrawing or drawing down pensions earlier makes sense,
• Explore gifting strategies while the current rules still apply,
• Speak with a financial adviser or estate planning professional to map out your options.

Contact our Inheritance Tax experts today if you require further advice.