Is my pension affected by Inheritance Tax?

Inheritance Tax (IHT) can feel worrying, but understanding how it applies to your estate – and your pension – can make things much clearer. Let’s keep it simple.

What Is Inheritance Tax?

Inheritance Tax is a tax on your estate when you die. Your estate includes:

• Property

• Money

• Belongings

• (minus any debts)

You don’t always pay IHT. You’re usually exempt if:

• The total value of your estate is below £325,000 (the “nil-rate band”), or

• You’re married or in a civil partnership and leave everything above the threshold to your spouse/civil partner, or

• You leave everything above the threshold to an exempt beneficiary, such as a charity or certain community organisations.

If your estate is above the threshold and not covered by exemptions, the excess can be taxed at 40%, which can lead to a substantial tax bill.

Pensions and Inheritance Tax – How It Works Now

Here’s the good news: right now, pensions are generally treated differently from other investments.

• For most people, defined contribution pensions (like those offered by Penny) are not counted as part of your taxable estate for IHT purposes.

• This makes pensions a tax-efficient way to pass on money to loved ones.

What happens to your pension when you die?

• If you have a defined contribution pension, your remaining pot can usually be passed to your chosen beneficiaries.

• You tell your provider who you’d like to receive your pension by completing a beneficiary nomination (sometimes called an “expression of wish”).

Tax treatment currently depends on your age when you die:

• If you die before age 75: Your beneficiaries can usually take money from your pension tax-free (if paid within two years of your provider being told of your death).

• If you die at age 75 or older: Your pension is still usually outside IHT, but your beneficiaries pay income tax at their normal rate on any withdrawals they make.

Important Change from April 2027: IHT on Unused Pensions

This is where things are changing.

Following the Autumn 2024 Budget announcement, the government has now confirmed (July 2025) that from 6 April 2027, unused pension funds and lump-sum death benefits will be included in your estate for Inheritance Tax purposes.

In simple terms, from 6 April 2027:

• Pensions will count towards your estate’s £325,000 IHT threshold

• Amounts above the threshold may be taxed at 40%

• Your executors (personal representatives) will be responsible for calculating and paying any IHT due on your pension

• The spouse/civil partner exemption continues – pension benefits passing to a spouse/civil partner remain IHT-free

• Death in service benefits remain EXEMPT from IHT

• Charity beneficiaries also remain exempt

The government estimates that:

• Around 10,500 estates (about 1.5% of deaths) that previously wouldn’t have paid IHT will now start to pay it, and

• Around 38,500 estates will pay more IHT than they would have under the old rules.

Draft legislation has been published and is expected to become law in the Finance Bill 2025–26. HMRC will provide further guidance and calculators before April 2027 to help people work out what this means for them.

What This Means for You

You don’t need to panic, but it is a good idea to plan ahead. In particular, you may want to:

• Review your beneficiary nominations: It may now be more tax-efficient to nominate your spouse or civil partner as your main beneficiary, with others as contingent/secondary beneficiaries.

• Consider taking financial advice: A financial planner can help you think through your estate planning and retirement spending strategy, especially if you have a larger pension pot or other assets.

• Keep informed: As HMRC guidance and tools are released, revisit your plans to make sure they still make sense.

How Penny Can Help

At Penny, we offer defined contribution pensions and can help you:

• Find and consolidate your old pensions into one easy-to-manage account

• Update your beneficiary nominations so the right people are named to receive your pension when you die

• Understand, in plain language, how changes to pension tax and IHT might affect your retirement planning

Pensions remain a powerful way to save for the future and support your loved ones. By understanding the rules – especially the changes coming in from April 2027 – you can make more informed decisions about both your retirement and your estate.

Please note that tax rules are subject to change and their impact will depend on your personal circumstances.