CURRENT POSITION

What’s the IHT position on pension savings before April 2027? 

IHT doesn’t usually apply when you pass on your pension rights, which can be a pot of cash and investments or the right to a pension, including any associated lump sum. This applies whether you die before you start taking your pension savings or after. In fact, unlike other types of investment, your pension fund(s) aren’t normally part of your estate, they are held in trust.  

Most pension savings, whether or not they are held in a registered scheme (one approved by HMRC), are held in discretionary trusts. The trustees decide who is entitled to a share of the money and other assets held by the trust. In practice, they earmark the funds for the person who pays into the pension and, on their death, their nominated beneficiaries. 

Further, the IHT legislation (Inheritance Tax Act 1984) says that transfer of pension savings you may have been entitled to and which are paid to your beneficiaries on your death don’t count as a transfer for IHT purposes. In plain English, this means they are exempt from IHT.  

 

What types of pension scheme currently escape IHT? 

The current IHT exemption applies to all registered pension schemes subject to the exceptions mentioned below This includes: 

• personal pension schemes (including self-invested personal pensions) 

• workplace pensions required under the auto-enrolment rules - these might be group personal pensions or hybrid final salary type schemes 

• stakeholder pension plans 

• additional voluntary contribution (AVC) plans and freestanding AVCs 

• final salary schemes. These days they are mostly for civil servants, and those working for the NHS and government bodies. 

The exemption also apples to qualifying recognised overseas pension scheme. These are typically paid into by individuals who have lived or worked abroad. You’ll know if you have one. 

Also exempt are pension savings in non-registered schemes such as funded unapproved retirement benefit schemes and funded employer-financed retirement benefit schemes where the pension savings and rights to benefits are held in discretionary trust.

 

Are there circumstances where IHT might be payable on pension savings?  

Yes, there are a number of situations where IHT can apply.  

Non-discretionary pension rights 

If the pension scheme is obliged to pay you or your beneficiaries a pension or lump sum, i.e. the payment is not at the discretion of the scheme administrators or trustees, the value of the pension rights will be part of your estate for IHT purposes.  

The types of pension scheme to which these apply are: 

• so-called buy-out plans, also known as Section 32 plans. These are a type of personal pension plan where a pension company accepts a transfer of your pension benefits under a scheme linked to your employment (an occupational scheme) particularly if the scheme being bought out is being wound up or you leave the employment to which the pension relates. You’ll probably know if you have a Section 32 plan but if you’re unsure check with the pension company or financial advisor 

• retirement annuity contracts (Section 226 contracts). These were the predecessor to personal pension plans. They ceased to be available in July 1986. However, the benefits from these could and often were placed into an individual discretionary trust and so like personal pensions they could escape the IHT net 

• certain types of occupational scheme, typically those set up for company owner managers or directors and senior employees, and some statutory schemes. Again, you’ll probably know if you have one of these.  

The two-year rule  

If you’re in poor health which you expect to shorten your life and you deliberately avoid accessing your pension savings or benefits so that more is left in your IHT-exempt pension fund, e.g. you defer taking an occupational pension (that’s a pension linked to your employment), IHT may be payable on the amount of pension income you could have taken.  

The sort of action that might cause deferral of pension benefits that HMRC might be looking out for are, where in the two years before death you: 

• transfer your pension benefits to another scheme 

• pay in significant extra pension contributions; or  

• transfer benefits in a Section 32 or Section 226 contract to a discretionary trust. 

Whoever is administering your estate, e.g. the executors, must report this type of transaction to HMRC on Form IHT409.

 

What about income tax on inherited pension savings? 

After you die the pension company will pay your pension savings or regular pension to the persons you nominated as beneficiaries. Whether or not the payment is taxable depends on how old you were: 

• if you die aged 74 or younger the whole pension savings are tax free for your beneficiaries 

• if you die aged 75 or older, the pension savings are taxable as income.  

Where the pension payments are taxable they count as additional income for your beneficiaries whether taken as a lump sum, spread over several or more years or paid out as a lifetime pension. Note that your beneficiaries don’t get the 25% tax-free amount that you’re entitled to when you receive a pension during your lifetime. 

 

Pensions and IHT from April 2027 

What’s changing and when? 

From 6 April 2027 an individual’s savings held in a pension fund will in nearly all circumstances be included in the value of their estate when they die. There are exceptions, e.g. a death in service pension and benefits. 

The draft legislation refers to “discretionary” pension savings, as it’s these that currently escape the IHT net. Discretionary means that under the terms of the pension trust, the trustees aren’t obligated to pay the deceased’s pension savings to the pension saver while they were alive or their estate on their death. 

The proposed new rules will apply to the estates of individuals who die on or after 6 April 2027. The draft legislation refers to “transfers occurring on or after 6 April 2027”. This could be interpreted as including the transfer of assets from an estate of someone who died before 6 April 2027 and who has pension savings that are not paid or transferred to their beneficiaries until after that date. This isn’t correct. The general IHT rules deem the transfer of a person’s estate as if it were made immediately before their death. This means that the new rules will only apply to estates of individuals whose deaths occur from midnight on the 6 April 2027.  

The new IHT rules will apply to pension savings and benefits whenever they were accrued. This means all pension savings accumulated prior to 6 April 2027 whether or not you have started to receive them, e.g. taking a money as a drawdown from your pension funds, will be subject to the new rules. 

Business and agricultural property relief for pension assets 

It’s currently possible and will continue to be so after 6 April 2027 for savings in certain types of pension fund to be invested in assets which qualify for IHT reliefs because they are used in a business or for agricultural purposes. 

An important side effect of the April 2027 changes affects pension assets which are not classed as qualifying business property or agricultural property and so don’t qualify for:  

• business property relief (BPR)  

• agricultural property relief (APR). 

Currently this isn’t an issue because such pension assets are exempt from IHT. However, after 6 April 2027 they will be subject to IHT but they won’t count as qualifying assets for BPR and APR.  

This problem is most likely to affect you and your estate if your pension funds are invested in business or agricultural assets, particularly within small self-administered schemes or self-invested personal pensions. It would be better for business or agricultural assets to be held outside your estate where they can qualify for 100% or 50% BPR and APR and thus wholly or partly escape the IHT net.  

If you have pension funds invested in assets that can qualify for APR or BPR, you should speak to your financial advisor about how they might be removed from your fund to your general estate so that relief of IHT in the form of BPR or APR can apply. 

 

Are there any exceptions to IHT post-April 2027? 

Yes, death in service benefits payable from both discretionary and non-discretionary registered pensions schemes and joint life annuities will remain outside the scope of IHT after the April 2027 changes, plus certain other types of broadly similar payments.  

Exempt transfers from inherited pension savings  

Where after the April 2027 changes your pension savings or benefits come within the scope of IHT this won’t apply to the extent your unused pension savings are left to: 

• your spouse or civil partner; and  

• a UK registered charity. 

Such transfers are exempt from IHT. 

This provides some opportunity for tax planning especially around the first exemption. This is considered in detail in the next section. 

 

Who works out the IHT and pays it? 

The short answer to the first part of the question is that the administrators of the deceased’s estate, e.g. executors, must work out the IHT payable on the general estate and any unused pension savings or benefits. As for paying the IHT on the pension savings there are three alternatives:  

• the personal representatives 

• the beneficiaries of the pension savings and benefits; or 

• the pension scheme administrators if the beneficiary makes a formal request that they pay the IHT out of the inherited funds. 

Example 

Rashid inherits pension savings of £100,000 from his father’s personal pension plan, with an IHT liability of £35,000, which is yet to be paid.  

Rashid notifies the pension scheme administrators that they should pay the IHT directly from the inherited funds. The scheme pays HMRC £35,000 from the pension fund. Rashid receives the remaining £65,000 which counts as his income. The personal representatives of Rashid’s father’s estate and beneficiaries are liable for any further IHT which, as often occurs, becomes payable as a result of an adjustment to the estate’s IHT account, e.g. because the valuation of assets or liabilities of the estate was not accurate when it was originally assessed for probate.  

Note that if the scheme administrators don’t pay the IHT within three weeks the beneficiaries become jointly liable for the tax. This rule is to ensure that there’s no undue delay in the tax being paid.

 

The interaction of IHT and income tax - what are the potential problems? 

A potential major problem with the new regime is that it’s possible the IHT liability may exceed the amount of pension savings and benefits drawn by beneficiaries. This would occur if the beneficiary or the personal representatives, e.g. executors, opted to pay the IHT on the inherited funds rather than the pension scheme paying it. To avoid the problem a special income tax deduction for the IHT paid applies if: 

• the beneficiary receives taxable pension income 

• the beneficiary (or the personal representatives) pays IHT on that benefit by 31 January following the end of the tax year.  

In those circumstances the beneficiary can deduct the lower of the following from their taxable income:  

• the IHT paid on the inherited funds; and  

• the amount of taxable pension savings.  

Where the IHT paid exceeds the taxable pension income in the year, the excess is deductible from pension savings taken in later years. In simple terms, the effect of the special tax deduction is that the person(s) inheriting the pension won’t have to pay income tax on it until the total of pension savings they take exceeds the IHT paid on the whole of the inherited pension savings. This is best illustrated with an example. 

Example 

Serena dies in July 2027 when her pension savings were £450,000. Serena has nominated her son Jack as beneficiary of her pension savings and her estate. He choose to take the inherited pension savings as a drawdown, i.e. as a regular payment rather than as a lump sum. 

After taking into account the proportion of the NRB attributable to her pension savings the IHT payable on them was £150,000 , which Serena’s personal representative paid with funds from her estate. 

In 2027/28, Jack draws income from the inherited pension savings of £30,000. This is all liable to income tax. The special income tax deduction allowed for the IHT paid is the lesser of: £150,000 (IHT paid) and £30,000 (taxable pension savings taken as drawdown income). 

Jack pays no income tax on the £30,000 he takes in 2027/28 and won’t pay any until the amount of pension savings he draws exceeds £150,000 (the IHT paid in respect of the total inherited pension savings). 

 

TAX PLANNING

When can I start tax planning for the new IHT regime? 

There are several steps you can start taking immediately. Not every step will suit everyone’s circumstances. For example, some steps might not be open to you unless you’re married or in a civil partnership. Furthermore, tax planning is an ongoing project, the steps that are right for you now might be different in future, say, because your wealth or income has increased or decreased.  

 

When do I need to consider IHT and income tax planning? 

The tax planning ideas here involve standard planning techniques focused around pension savings. It’s important to remember that you only need consider IHT planning around your pension savings and general estate if your wealth is, or you expect it to be, sufficient to exceed the IHT nil rate bands (NRBs) available. Until at least April 2030, for individuals these are £325,000 for your general estate including pension savings, plus £175,000 (residence nil rate band (RNRB)) to be used only against the value of your home if you own one at the time of death, or if you don’t have a home but your estate includes value derived from the sale of one.   

 

How do I access my pension savings and benefits? 

All the time that your pension savings and benefits are accumulating in one or more pension schemes there is nothing you can do to allocate them in an IHT-efficient way. However, if you access your pension savings, i.e. by taking a lump sum or pension, you can take steps to reduce the IHT potentially payable on them. This must be balanced against the income tax cost of taking the pension savings.  

Simply taking your pension savings, paying income tax on them and holding on to the balance will mean that your combined income tax and IHT will be greater, regardless of the rate of income tax you pay, than if you had left the money in your pension scheme. To create an overall tax advantage you must do something with the money you take from your pension.  

Taking your pension savings and retaining them not only increases the overall tax cost compared with not taking them but it removes them from the tax-free environment as income and gains derived from assets while they are held in a registered pension scheme are tax free. Income and gains made from assets you hold personally are generally taxable.  

 

How do I use a tax-free lump sum? 

Most pension schemes allow you to take a tax-free lump sum (known as tax-free cash or the pension commencement lump sum) equal to 25% of the pension fund value. Taking this will not affect your income tax liability. 

Usually, you can take your tax-free cash without committing to taking any more from your pension fund. Check your pension scheme documents or contact the pension administrator to check your entitlement to tax-free cash.    

Having moved value from your pension savings you can use it IHT efficiently by: 

• making gifts to those who you want to benefit from your pension savings after your death 

• buying off-the-peg IHT-saving products 

• putting the money in IHT-efficient investments. 

Making gifts 

You can give away as much of your wealth away as you wish. After three years the amount of IHT that would otherwise be payable on the gift is reduced in stages until the seven-year point is reached when it becomes fully exempt from IHT. 

Using off-the-peg IHT-saving schemes 

There are two main types of scheme you can buy into primarily for the purpose of reducing your estate for IHT purposes. These can be funded from your general estate or from your pension savings.  

A tax-efficient method of funding an IHT-saving product is to take a tax-free cash lump sum from your pension. 

To find out more about investing in the IHT-saving schemes explained below you’ll need to speak to a financial advisor as these types of investment are considered “sophisticated” and so not readily available except through an advisor.  

Discounted gift schemes 

Discounted gift schemes (DGSs), also known as discounted gift trusts, are designed to reduce your estate primarily and in so doing reduce the potential IHT liability when you die. The aim of a DGS is to shift value from your estate to your beneficiaries by means of a specially structured gift arrangement. 

The normal rules for potentially exempt or chargeable lifetime transfers apply to gifts made through a DGS. Such gifts, therefore, are full effective in reducing your estate until seven years has elapsed from the date of the gift.  

However, some reduction (taper relief) in IHT might apply after three years. This depends on whether taking account of other lifetime gifts, any part of the gift’s value exceeds the IHT NRBs. If so, the IHT payable is reduced by tapering relief. This relief increases year on year until the gift becomes fully exempt, i.e. after seven years have elapsed from when the gift was made. 

DGSs work like this: in return for you making a gift to a trust (the DGS trust), you are entitled to receive an income from the trust for the remainder of your life or 20 years, whichever comes first. The income is fixed at a rate so that ultimately when you die there will be some capital left in the trust which then passes to your beneficiaries named in the trust and chosen by you when the trust was created. The value of the income you expected to receive, based on your life expectancy, is compared to the amount of the gift you made to the trust. The difference is the “discount” which results in the IHT saving. 

Example 

Tania is a widow aged 80 and in reasonable health. She has a significant estate mainly in assets that produce little or no income. She gifts £300,000 to a DGS trust. The trust invests this in a UK insurance bond. This allows it to take an income of 5% of the amount invested tax free each year and pass it to Tania, also tax free. The insurance company’s actuaries estimate Tania’s life expectancy to be 88 years. Over that time she’ll receive income of £120,000 (£300,000 x 5% x 8 years). As the original gift to the trust was £300,000 and Tania’s predicted income from it is £120,000, the discount is £180,000. IHT is potentially saved on this amount when Tania dies.  

IHT loan schemes 

A loan scheme is worth considering if you want to mitigate a potential IHT liability but may need access to your capital.  

Broadly, a loan scheme works so that you make a loan to a trust (unlike a DGS no gift is involved). The money can come from your pension savings as tax-free cash. 

At this point the plan is IHT neutral. You’ve reduced the cash in your estate by making the loan but because it’s a loan you’ll get your money back, albeit over a number of years. The trust uses the money it borrowed from you to purchase an investment bond (insurance bond). The loan repayments the trust makes to you are funded by cashing in up to 5% of the original cost of the bond. This isn’t taxable income for the trust. This means that usually the loan is repaid over a period of 20 years so that you get all your capital back. This provides you with a steady income over the 20-year period.  

Any growth in value of the bond belongs to the beneficiaries of the trust, i.e. the persons you wish to benefit from your pension savings. The IHT saving results from any increase in the value of the bond being outside of your estate for general and IHT purposes. 

Investing in IHT-efficient investments  

Before explaining how to use IHT-efficient investments for tax planning it’s important to understand the basics of the IHT relief behind them.  

Money invested in trading businesses qualifies for IHT business property relief (BPR). This can be shares in a limited company, a share of a partnership or a business you run as a sole trader. The effect of the relief is to ignore the value of assets qualifying for relief. There’s a similar relief for agricultural property (APR), essentially farms. In a highly publicised announcement in the 2024 Autumn Budget a cap will apply to the amount of relief available from 6 April 2026. Until then qualifying assets are ignored or their value discounted by 50% when working out the IHT on an estate. There are of course many conditions to BPR and APR which will continue to apply after April 2026. 

From April 2026 full (100%) BPR and APR will be capped at £1 million. Note that this cap applies to both reliefs together, so you can’t claim £1 million of each. The 50% rate relief will apply to the value of qualifying assets above £1 million. 

If you don’t currently have assets qualifying for BPR and APR, you can invest in businesses to make use of it. Many banks and investment businesses market IHT-friendly portfolios of companies in which you can buy shares that qualify for BPR.  

Although BPR doesn’t usually apply to shares in companies quoted on a stock market, shares in companies quoted on the alternative investment market (AIM) do. Companies listed on the AIM are well established and so make relatively safe places to invest your money. Investment businesses create an IHT-efficient investment by spreading the money you invest with them among a number of AIM or other qualifying companies.  

The Autumn Budget 2024 changed the conditions and rate of BPR on AIM etc. shares. For shares held in companies listed on AIM (and any other secondary exchanges where shares are designated as unlisted) the rate of relief will be halved. Therefore, instead of the full value of the shares being excluded for IHT purposes, if an estate includes AIM shares and the estate is large enough so that IHT is payable, the value of AIM shares subject to IHT will be 20%, i.e. half the normal rate of IHT, instead of zero.   

 

How could I use pension income? 

Depending on your financial circumstances you might need some or all of your pension income in retirement. This doesn’t prevent you from removing some of it from your estate in order to reduce IHT. The normal expenditure out of income exemption applies where you give away some of your income on a regular basis. This would allow you to give away any excess pension income to prevent it being part of your estate for IHT purposes on death. The exemption removes the money you give away as soon as the gift is made, there’s no waiting period. 

To qualify for the exemption, the gifts must be: 

• part of normal expenditure, i.e. made on a regular basis, but not necessarily an identical pattern of gifts 

• paid out of your income, taking one year with another. That means if you don’t have enough income in one year to make or cover the regular gifts you can take account of the previous or following years’ income  

• leave you with enough income to maintain your usual standard of living. 

There’s no definition for tax purposes of what counts as income but typically it can be your pension (state or private), a drawdown from your pension savings, salary, business profits, dividends, interest rental income; it even includes income from non-taxable sources such as ISAs and insurance bonds. 

HMRC deems that withdrawals from investment bonds are capital in nature even though any gains are subject to income tax through the chargeable events legislation. Consequently, bond withdrawals cannot be used to increase the amount of surplus income which can be given away. 

When making gifts it’s important to keep a thorough record of how much, when and to whom they are paid. Keep the record with your financial papers and let the persons named as executors of your will know about it. They will need the information when completing the IHT forms for HMRC.  

The following example shows the potential IHT savings by using your pension income to fund gifts during your lifetime. 

Example 

Scott is 66 and retired and in receipt of the state pension. His estate is currently worth £900,000 which includes investments of £400,000. He also has pension savings of £400,000 in various money purchase funds. He’s currently using his investment income and state pension to live off, around £36,000 per year. He hasn’t touched his pension savings because under the current regime they are liable to IHT and so he plans to leave the funds to his two children. However, because his pension savings will become liable to IHT if he dies on or after 6 April 2027, he wants to reduce his pension savings and correspondingly the IHT bill. 

As he already has enough income from his state pension to live on, any pension savings he takes as income will be surplus to his needs and so can be given away to his children without affecting his standard of living. The following table compares the IHT positions if Scott lives another ten years and: 

• leaves his pension savings untouched, versus 

• drawing a regular sum from his pension and giving away the after-tax amount to his children each year.  

To simplify the picture we assume no growth in the pension fund and that Scott is a basic rate taxpayer. In real life the effect of growth in the pension fund would not materially change the overall financial position.  

Transactions
Pension savings	£400,000	£400,000
Annual amount drawn by Scott		£14,000
Income tax on pension drawn (net of 25% tax free amount) at 20%		£2,100
Net pension savings		£11,900
Gift to Scott's sons		£11,200
Amount liable to IHT on Scott's death	£400,000	£260,000
IHT payable at 40% after NRB of, say, £100,000	£120,000	£64,000
Net amount left for Scott's sons before income tax	£280,000	£196,000
Income tax on inherited pension savings at, say, 20%	£56,000	£39,200
Net of IHT and income tax amount inherited	£224,000	£156,800
Amount received by Scott's sons during his lifetime (over ten years)		£119,000
Total amount received by Scott's sons	£224,000	£275,800

 

The advantage to drawing the pension and giving it away during Scott’s lifetime is significant. However, this is a simple example which demonstrates the principle. In practice other factors would need to be considered which could reduce or increase the overall tax advantage. The factors in question would be the rate of income tax payable by Scott when he drew the pension and the rate payable by his sons when they received the inherited pension.   

In our example Scott could use other exempt gifts to reduce his estate.

 

How do I change my pension beneficiaries? 

If you’re married or in a civil partnership, gifts to your partner are exempt from IHT. You can use the exemption to help mitigate IHT on all or part of your estate. This is a standard IHT planning technique.  

This technique is especially useful if you or your spouse/civil partner have a short life expectancy. 

The best way to illustrate how and in what circumstance to use the IHT spousal exemption is with an example.  

Example 

Harry and Sally are married. Harry is already accessing his pension savings and Sally intends to start in the next few years. Harry’s estate is worth £500,000 (including a 50% share of his home). In addition, his pension savings, which are in a money purchase scheme, are worth £400,000. Currently, his will leaves his share of the family home and all his other assets to Sally. Harry has nominated his son as beneficiary to his unused pension savings when he dies. 

If Harry dies before 6 April 2027 (assuming his estate is worth the same as it is now) there’ll be no IHT on his estate regardless of who he leaves it to because the value of his general estate is covered by the general NRB (£325,000) and the share of his home by the RNRB (£175,000) - the pension savings are exempt. 

If Harry dies after 5 April 2027 his estate for IHT purposes will incorporate the value of his unused pension savings, meaning that the part in excess of the NRBs (£400,000) will be taxed at 40% (£160,000) a proportionate part of which will relate to Harry’s general estate and the remainder payable from the unused pension savings.  

If Harry changes the person nominated to receive his pension savings from his son to his wife, should she survive him, the whole estate including the pension savings will escape IHT. If he also provided a letter of wishes for his executors asking Sally to make a gift of £400,000 to their son it would not be part of her estate when she dies and provided she survives the date of the gift by seven years, IHT on the pension savings will have been entirely avoided.