Pensions and inheritance tax - don’t let the 40% headline do your planning
Peter McGahan
Monday 14th September, 2026.
PENSIONS have had a useful second job for many years – security in retirement.
Their second was less obvious, but very valuable. If you had enough savings and investments elsewhere, your pension was often one of the last pots you touched because most pension death benefits sat outside your estate for inheritance tax.
That changes from April 6, 2027.
On deaths from that date, most unused pension funds and pension death benefits will be brought into the inheritance-tax calculation.
That doesn’t mean every pension suddenly attracts 40 per cent tax. Some defined benefit pensions simply stop when you die and may have nothing left to value. Certain dependant pensions, qualifying annuities and some death-in-service benefits are also excluded. Money passing to a spouse or civil partner may still qualify for the normal inheritance-tax exemption.
So, as ever, the headline is simpler than the reality.
And the danger is seeing those dramatic headlines of “40 per cent inheritance tax on pensions” and doing something daft.
One of the most important areas to watch is around estates worth £2million.
There is an additional inheritance-tax allowance linked to passing your home to direct descendants, called the residence nil-rate band. It is currently £175,000.
However, once your estate exceeds £2 million, that allowance starts disappearing at £1 for every £2 above the limit.
Imagine your estate is already £2million before counting your pension and you have the full allowance available.
Now add a £100,000 pension.
Your estate has increased by £100,000, but you can also lose £50,000 of that additional inheritance-tax allowance.
So, if your other inheritance-tax allowances are already used, potentially £150,000 more becomes exposed to inheritance tax because of that £100,000 pension.
At 40 per cent, that is £60,000.
In other words, the effective inheritance-tax cost on that extra £100,000 can be 60 per cent, not 40 per cent.
That is the sort of detail worth knowing before anyone starts pressing eject buttons.
Age 75 also remains important.
Broadly, if you die before age 75, many pension death benefits can still be paid without income tax, subject to the relevant rules and allowances. If you die aged 75 or over, inherited pension payments are normally taxable as income when the beneficiary takes them.
That means the same pension wealth can potentially suffer inheritance tax first and income tax later.
But please don’t add 40 per cent inheritance tax to 45 per cent income tax and announce that the Government takes 85 per cent. Tax doesn’t work like that.
As a simplified example, imagine £100 is fully exposed to 40 per cent inheritance tax. £40 goes, leaving £60.
If the beneficiary then withdraws that £60 and pays income tax at 45 per cent, another £27 goes.
They receive £33.
That is an overall tax cost of 67 per cent, not 85 per cent. Still painful enough without improving the story.
So, should everyone start emptying their pensions before April 2027?
Absolutely not.
Once the new rules apply, take £100,000 from your pension and leave £100,000 sitting in your bank account and you haven’t reduced what may be exposed to inheritance tax. You have simply moved the money from one pocket to another.
Worse, you may have paid income tax to get it out and removed it from the tax-efficient pension environment.
The real question is what happens to the money afterwards.
Will you genuinely spend more in retirement? Could you help children or grandchildren while you are alive? Do regular gifts from surplus income fit your circumstances? Do you need to preserve as much pension capital as you previously thought?
Review your pension nominations too.
Automatically leaving everything to a spouse may still make perfect sense, but don’t assume it magically solves the inheritance-tax problem. It may simply postpone it.
If a spouse inherits pension money into beneficiary drawdown and still owns that inherited pension when they later die, it can form part of their own pension estate for inheritance-tax purposes.
And there is an easily missed twist here.
That can include pension money inherited before the new rules begin. If someone inherited a pension years ago and dies after April 6, 2027, with some of that inherited pension still sitting in beneficiary drawdown, it can still be caught.
That could be a significant surprise for families who thought an old inherited pension was permanently outside inheritance tax.
Don’t make irreversible decisions simply because April 2027 is approaching. More detailed Government guidance note is still to come in the Autumn.
The pension hasn’t suddenly become a bad place for your money.
It has simply lost one of the tax advantages which used to make “leave the pension until last” such an easy answer. If you have an inheritance tax or pension query, please email info@wwfp.net
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
