Understanding the Impact of UK Inheritance Tax on Pension Savings

Pensions have long been one of the most useful estate planning tools in the UK, thanks to their preferential treatment under inheritance tax rules. That will change on April 6, 2027, when new IHT rules end the exemption of pensions from a person’s taxable estate.

In this article, we’ll examine how changes to UK inheritance tax may impact your pension savings. To help you prepare for the upcoming reform, we’ll also cover pension-specific steps, as well as some general estate-planning strategies. 

How Did Inheritance Tax on UK Pensions Change?

Pensions have historically sat outside the taxable estate for IHT purposes, allowing you to use them for multi-generational wealth transfers without creating a tax liability or taking up portions of your nil-rate band. This was possible because most UK pensions were kept in discretionary trusts, which gave the pension scheme trustees control over who received death benefits. 

However, from April 6, 2027, any unused funds left in a discretionary pension scheme after death, as well as any death benefits due, will be considered part of your estate for UK IHT purposes. 

The new rules make your personal representatives, rather than pension scheme administrators, in charge of reporting and paying any inheritance tax due on unused funds and death benefits. 

Pensions or Death Benefits Exempt Under the New Rules

While the new rule for pension savings and death benefits will bring most of them under the scope of IHT, some will remain tax-exempt. Any part of your estate that passes to your spouse or civil partner falls under the spousal exemption, including pensions and death benefits. Transfers to charities are treated the same under the new IHT framework.

Other exemptions include: 

• Joint life annuities: If your annuity pays a survivor’s pension after your death, that pension will remain outside the scope of IHT, regardless of your relationship with the beneficiary 
• Dependants’ scheme pensions: Death benefits paid to a qualifying dependant (spouse, civil partner, child, or another financially dependent person) are excluded, regardless of the pension arrangement they’re paid from
• Trivial commutation: When a small pension income from a dependant’s scheme pension is replaced with a single lump-sum payment, that payment is excluded from IHT on the same basis as the pension it replaces
• Death-in-service benefits: Payments tied specifically to being employed at the time of death are excluded from IHT, whether they are lump-sum or pension income, and regardless of trustee discretion over payment
• Non-UK pensions: If you are not a long-term resident of the UK at the time of death, any non-UK pension will fall outside the scope of IHT

What Is the Impact of the IHT Rule Changes?

Bringing pensions under the scope of IHT can impact you in two ways: 

1. It can create an IHT tax liability
2. It can increase the amount due for IHT

The government has estimated that 10,500 estates will have a new IHT liability as a consequence of the rule changes regarding pensions. It is also estimated that 38,500 estates will pay more inheritance tax than before, for a total of 49,000 estates affected. 

The number of estates with inheritable pension wealth in the first year of application is expected to be around 213,000, 23% of which will be affected by the new rules.

Double Taxation Jeopardy 

The new rules also leave open the possibility that your pension will be subject to both inheritance tax, as part of your estate, and income tax, as the beneficiary’s income. 

If you die before turning 75, any pension or benefits you pass on to your beneficiaries are usually exempt from income tax, provided they stay within your lump sum and death benefit allowance. 

If you die after turning 75, those funds are taxed as part of the beneficiary’s income. Since IHT applies first, income tax is levied only on the remainder, preventing full double taxation of the entire sum. However, it can still produce a significant combined liability: depending on the beneficiary’s tax bracket, the effective rate can reach 64%–67%. 

IHT Pension Changes as Part of a Broader Trend

The impact of IHT pension changes should also be viewed in the context of other recent changes to the IHT rules. These changes further expanded both the number of taxable estates and the potential tax charge on estates with existing tax liability, and include: 

• End of the non-dom regime: In April 2025, the UK replaced its domicile-based system with a long-term residence system, bringing foreign assets that were previously shielded under the scope of IHT
• Freeze on IHT bands: The nil-rate and residence nil-rate bands are both frozen until 2031, pulling more estates over the threshold through asset appreciation alone
• Cap on agricultural and business property relief: As of April 2026, the 100% IHT relief on qualifying agricultural and business property will apply only to the first GBP 2.5 million of combined assets, with the rest getting a 50% IHT relief
• AIM shares relief cut: As of April 2026, available relief on alternative investment market shares has been reduced from 100% to 50%

None of these changes operates in isolation, and their combined effect on your estate can be difficult to anticipate without a full review of your circumstances.

How To Prepare for the New UK Inheritance Tax Rules on Pensions

While the changes don’t take effect until April 2027, there are steps you should consider before then, such as: 

1. Reviewing nominated beneficiaries
2. Revisiting the withdrawal order 
3. Considering purchasing annuities 

Review Nominated Beneficiaries

You should make an account of all your pensions and their nominated beneficiaries, including any contingent beneficiaries. Since spousal transfers remain IHT-free, while transfers to children and others may not, redirecting your pension to a spouse or civil partner can reduce your overall IHT liability. 

Plan Withdrawal Order

When used as a vehicle to pass on wealth IHT-free, pensions were typically left as the last asset to draw from. The generally accepted strategy was to exhaust other assets first, such as individual savings or general investment accounts, before drawing on the pension.

Since pensions have lost their tax-advantaged status under IHT, and consequently their effectiveness as a wealth-transfer vehicle, the benefit of leaving them last has been diminished. You should reconsider the order in which you draw on your assets and develop the most tax-efficient plan that takes into account the new rules.

Consider Purchasing Annuities

Purchasing an annuity can help reduce a future IHT liability. If you use your pension savings to buy a joint life annuity and the other person outlives you, their ongoing annuity income stays outside the estate for IHT purposes. It can also bypass probate, allowing for more direct succession. 

Annuities come with a trade-off, however. Income from them is still taxable, and it might push you or the other beneficiary into a higher tax bracket. For these reasons, it’s best to consult a financial planner before purchasing one. 

Additional Estate Planning Steps to Consider

In addition to preparing for specific changes to the tax treatment of unused pension pots, consider taking estate planning steps to reduce overall exposure to inheritance tax. These include: 

1. Reducing the size of the estate through lifetime gifting
2. Taking out life insurance to prepare for IHT liability
3. Planning your tax residence to protect overseas assets

Reducing the Size of the Estate Through Lifetime Gifting

You can use lifetime gifting to reduce your inheritance tax liability. Some gifts are exempt from IHT or covered by allowances. These include: 

• Gifts to your spouse, provided that they live in the UK permanently and you’re legally married or in a civil partnership
• Gifts to a charity or a political organisation
• Up to GBP 3,000 worth of gifts in a single tax year (annual exemption) 
• Up to GBP 250 per person per year (small gift allowance)
• Up to GBP 5,000 wedding gift to a child, GBP 2,500 to a grandchild, or GBP 1,000 to anyone else 
• Regular gifts you make from your income 

Gifts not covered by an exemption or allowance can also fall outside the scope of IHT if you live more than seven years after gifting them. This is called the seven-year rule, and it stipulates a taper relief for lifetime gifts that are considered Potentially Exempt Transfers (PETs):

Years Lived After Gifting	IHT Rate on the Gift
3–4 years	32%
4–5 years	24%
5–6 years	16%
6–7 years	8%
7+ years	0%

For all types of gifts, it’s important to document the recipient, the date the gift was made, and its value. You should document the source of funding for the gift, if applicable. 

Taking Out Life Insurance To Prepare for IHT Liability

You can use life insurance to provide your estate with funds for inheritance tax liability, preventing the sale of valuable assets to cover the tax bill. The two types of life insurance policies you can use in different circumstances are: 

1. Whole of life insurance policy: Provides a lump-sum payment after your passing, allowing you to cover the final IHT bill 
2. Term protection insurance policy: Provides coverage only for a specified term, making it especially effective if you have made significant PETs 

If you plan to take out whole of life insurance, you should also consider placing it within a trust to remove it from your taxable estate. If you choose term protection insurance, you might be able to renew it after the term ends, but you should expect higher premiums.

Planning Your Tax Residence To Protect Overseas Assets

Replacing the deemed domicile rules with long-term residency based on tax resident status has made it easier for your foreign assets to become subject to inheritance tax. Under the new rules, you’re a long-term resident if you’ve been a tax resident for only 10 of the previous 20 years. 

Upon departing, you may also remain exposed to the UK IHT for a “tail” period that spans from 3–10 years, depending on how long you’ve been a UK tax resident before departure. Because of the new provisions, the decision to remove UK long-term residency is not only crucial for estates with significant foreign assets, but also potentially urgent. 

Changing your tax residence involves a complex sequence of steps. The process involves selecting a favourable tax jurisdiction, navigating its immigration system, and following UK residence guidelines to the letter to remove long-term residence status. 

Any mistake during the process, or even improper sequencing of steps, can cause delays or even more significant derailment of your tax residence plans. Working with professional advisors can help you avoid these issues, ensuring you choose a tax-friendly destination and move through the process without major roadblocks. For a seamless transition to your new residency, contact Nomad Capitalist. 

Choose Your Next Tax Jurisdiction With Nomad Capitalist

Nomad Capitalist is a consultancy firm specialising in global mobility and wealth preservation. We’ve helped more than 1,500 clients develop and execute their international strategy by obtaining a second residency, reducing tax liabilities, accessing international banking, and exploring investment opportunities abroad. 

Our core service is the Action Plan, a step-by-step blueprint for achieving your objectives. Whether you want to protect assets, increase your cross-border optionality, or diversify your investment portfolio, we can create and implement a strategy to meet your goals quickly and efficiently.

Here’s what partnering with Nomad Capitalist on an Action Plan looks like: 

1. We ask you to fill out a form to help us determine whether you’re a good match
2. We schedule a 45-minute onboarding call to learn more about your situation and goals
3. Your case manager develops an Action Plan and presents it to you for approval
4. We implement the Plan over 12 months, providing management and assistance 
5. You continue receiving support from us even after the Plan is implemented

To help you protect your offshore assets from UK inheritance tax, Nomad Capitalist can assess the most favourable tax jurisdiction for tax residence. We can also assist with meeting the residency requirements and provide support throughout the application process. To get started, call Nomad Capitalist right away!