That logic is changing. For deaths on or after 6 April 2027, unused pension funds will be brought within the value of the deceased’s estate for Inheritance Tax (IHT), creating a tax charge of usually 40% on what can be a significant asset. This, in turn, is set to generate tax charges in the tens- and hundreds- of thousands for many estates.
IHT will be due in addition to the existing Income Tax rules, doubling up across the two taxes. This can create effective tax rates of 52%-67%+ for pension funds on death. While this feels punitive, it does not mean that pensions are no longer attractive savings vehicles. It does, however, mean that the purpose and timing of pension withdrawals need to be reconsidered as part of a joined-up retirement and estate plan.From retirement fund to family asset: how the rules evolved
Before the pension freedoms introduced in April 2015, we were used to a penal taxation regime for pensions on death. A defined contribution pension could suffer a special lump-sum death-benefit charge of up to 55%. The available benefit routes were also more restricted, particularly for beneficiaries who were not dependants.
The Taxation of Pensions Act 2014 helped create a more flexible system from 6 April 2015. Not only was the 55% tax charge removed, but a defined contribution pension could also pass to a dependant or successor as a pension, allowing money to remain inside a pension wrapper. This created an environment where funds could be passed tax efficiently on death and retained in a tax-efficient pension wrapper indefinitely.
So, over the course of a few years in 2015-2016, we went from a regime where pensions were taxed heavily on death, to a far more favourable regime, typically with no immediate tax payable upon death. The introduction of IHT from April 2027 therefore feels like we are going back towards the “old” system of pension taxation on death. This is why we wouldn’t expect an imminent reversal of the upcoming changes in 2027 (though of course, rules can change).
For defined contribution pensions, the taxation on death depends on how old the pension member was when they died. Broadly, if the member dies before age 75, most payments can be made free of income tax, subject to available lump sum limits and timing of the payment.
If the member dies aged 75 or over, payments made directly to a beneficiary are taxed as income, at their marginal rate of income tax. However, this income tax charge can be deferred if the pension is transferred to the beneficiary as a “Beneficiary Drawdown” arrangement, under which the beneficiary receives the pension fund, rather than a lump sum cash payment. The beneficiary would then pay income tax when they choose to draw from this inherited pension fund.
Beneficiary drawdown is therefore incredibly valuable; rather than receiving the whole fund in one tax year as a lump taxable sum payment, beneficiaries may instead control the withdrawals and therefore control their taxation. This allows beneficiaries to indefinitely defer taxation on pension death benefits, which we expect is the reason why Inheritance Tax is being introduced – to create some immediate taxation receipts.
When the Lifetime Allowance was abolished from 6 April 2024, it was replaced by allowances governing what tax-free lump sums could be paid on death. The idea of these new allowances was that whilst you weren’t taxed on saving during your lifetime, you would be taxed if you hadn’t used the funds yourself.
The standard Lump Sum and Death Benefit Allowance (LSDBA) is £1,073,100, but this would be higher if you had Lifetime Allowance protection(s). Tax-free lump sums taken from pensions during life would use part of the LSDBA, leaving less available for relevant lump-sum death benefits.
Where someone dies before 75, lump sum death benefits above the remaining LSDBA are taxable as income at the recipient’s marginal rate. For example, if the LSDBA remaining is £800,000 and a lump sum death benefit of £1,000,000 is paid, £200,000 would be taxable as income.
Where someone dies after 75, the full lump sum would be subject to income tax, without an allowance for the LSDBA. Remembering that death is more likely to happen after age 75, this would again create significant tax charges.
However, designating funds to beneficiary drawdown is not itself a lump-sum payment against the LSDBA. It is therefore possible to leave funds to beneficiaries without creating an immediate income tax charge. If the pension member died under the age of 75, withdrawals from that beneficiary drawdown pension would remain income-tax-free for the rest of the beneficiary’s life.
In the context of pre-2015 death benefits and the removal of the Lifetime Allowance, it has perhaps felt ‘overly-generous’ that significant pension funds, greater than the LSDBA, could be transferred without tax.
However, beneficiary drawdown is not universally available. Some legacy contracts permit only a lump sum or restrict who can use drawdown. Individuals and their advisers should ask their pension provider, in writing, whether dependant, nominee and successor drawdown are available to future beneficiaries of the fund.
This set of rules set a challenge for the treasury. The intention of the LSDBA was to tax large pension funds on death, rather than during lifetime. But beneficiaries could still defer taxation indefinitely if beneficiary drawdown was available. We expect this is why Inheritance Tax is being introduced.
For death on or after April 2027, most unused pension funds and pension death benefits will be included in the estate for IHT. Personal representatives will also be responsible for reporting and paying the tax alongside the pension schemes. This will create significantly more administration for personal representatives and pension scheme administrators.
Certain benefits are typically excluded from IHT, including registered-scheme death-in-service benefits and some continuing dependant’s scheme pensions.
The spouse or civil-partner exemption still applies for IHT-free transfers on death. A pension benefit passing to a surviving spouse or civil partner may therefore avoid an immediate IHT charge, although the surviving spouse’s eventual estate and the income tax treatment of withdrawals still need consideration.
While death under the age of 75 and correct use of beneficiary drawdown could still mean Income Tax does not apply, Inheritance Tax would still be due. Where death occurs from age 75, the pension fund would suffer both Inheritance Tax and Income Tax. If a 40% IHT charge is followed by a 45% Income Tax charge, this creates an effective tax rate of 67% on death.
This tax rate can be worse for estates that are pushed above £2million by including the pension, because they will also lose the Residence Nil Rate Band (RNRB). The loss of the RNRB can create IHT rates of up to 60%, in addition to the income tax that could apply, resulting in effective rates of up to 78%. Anyone who has been trying to keep their estate below £2million will therefore need to readdress any IHT planning they have been undertaking.
Even without IHT applying, normal life expectancy means that death is expected to occur after age 75 for most people. We have therefore often been planning based on beneficiaries receiving post-75 death benefits and being subject to income tax on what they receive. The first question is still therefore: “What rate of tax will you pay vs your beneficiaries?” If you could pay income tax at 20%, but have beneficiaries who would pay tax at 40% or 45%, it has been worth considering still making pension withdrawals.
The addition of IHT will change the equation so that even more people will be encouraged to draw from their pension as part of their retirement and estate planning. The aim now being to use the pension to fund your own retirement expenses, reducing your reliance on other assets within the estate. These other assets can then be more readily gifted or restructured to reduce the Inheritance Tax burden on the estate as a whole.
This does not mean “empty the pension as quickly as possible”. Large withdrawals can create avoidable lifetime income tax, change contribution allowances, remove funds from a tax-sheltered environment and increase the value of the taxable estate if the money is simply retained.
The more useful approach is going to be a deliberate withdrawal strategy; to meet spending from the pension where tax bands allow, then plan what to do with any surplus. That might include building accessible reserves, funding later-life expenditure, supporting family during life or making gifts. Regular gifts made from genuine surplus income can be immediately exempt from IHT where the conditions and evidence are satisfied; larger outright gifts are usually potentially exempt transfers and normally require seven years’ survival.
Changes in death benefits and prevailing interest rates mean it is worth reconsidering annuities. An annuity converts some or all of a pension fund into a secure income. Reducing exposure to investment volatility and the risk of outliving the fund. This is at the cost of reduced death benefits for future beneficiaries.
If preserving an untouched pension is less compelling post-tax after April 2027, the certainty offered by an annuity may carry greater relative value, especially for essential expenditure.
But the trade-off remains. A single-life annuity with no guarantee or protection may stop at death, leaving nothing from the purchase price for beneficiaries. A joint-life annuity, guarantee period or value protection can provide benefits after death, but will reduce the starting income.
Joint-life annuities are also particularly interesting for unmarried couples. If an unmarried partner receives pension death benefits, IHT would usually apply. However, benefits paid under a joint life annuity should not be subject to IHT.
For many people, the answer will not be “drawdown or annuity” but a blend. Comparing options should include the value of income received during life, not just the amount left at death.
Pensions continue to offer valuable tax relief on contributions, tax-sheltered investment growth and flexible retirement benefits. The forthcoming IHT rules do not remove those advantages. They do, however, weaken the assumption that has prevailed in recent years that the pension should always be the last asset spent.
The new approach is to use pension income deliberately: to support the retirement the fund was built for, to manage lifetime tax sensibly and to create flexibility for planning elsewhere in the estate. That requires more than a one-off decision. Withdrawal levels, beneficiary options, nominations and estate exposure should be reviewed regularly as family circumstances, pension values and tax rules change.
If you would like to understand how the pension and IHT changes could affect your retirement income strategy, speak to one of our financial planners. A review can identify whether your pensions provide the right death-benefit flexibility and whether your planned withdrawals remain aligned with your lifetime needs and wider estate.
This article is for general information only and is based on legislation and published policy as at July 2026. It is not personal financial, tax or legal advice. Tax treatment depends on individual circumstances and may change.
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