Most people do not realise that pensions, for many years, have sat outside the inheritance tax system. For families with meaningful wealth, especially those with pension funds of £500,000 or more, this has been one of the most powerful planning tools available.
That is about to change.
From 2027, unused defined contribution pension funds will be drawn into the inheritance tax net. The legislation is not final, but the direction is clear. If you want to protect your family, the time to understand the rules is now, not when your children are dealing with your estate.
Here is the important part: the way the tax is paid is not automatic. Your beneficiaries and executors will have options, and the choice they make will affect costs, timing, cash flow, and in some cases, stress levels.
Let’s look at what is actually changing and what your options will be.
Under the proposed rules, if you die with money left in a defined contribution pension, the value of your pot will be added to your estate for IHT purposes.
So if you have:
• £1,000,000 in pensions
• £1,000,000 in other assets
Your estate for IHT is £2,000,000.
That is a surprise for many people who assumed pensions were always outside the estate.
The personal representatives (your executors) will be responsible for reporting the pension value and making sure the tax is paid.
This is a small but important shift.
Until now, your estate and your pensions could be treated as separate worlds. From 2027, they are connected.
This is where Aberdeen’s article is especially useful. When IHT applies to a pension death benefit, your family can choose one of three ways to pay it.
This is the simplest.
Your executors use money from your free estate (cash, investments, property proceeds) to pay the tax bill.
The pension money then passes to your beneficiaries as normal.
This is clean, but only works smoothly if your estate has liquidity. Families who are asset rich and cash poor may find this slow or awkward.
Some UK pension schemes will allow the tax to be paid directly from the pension pot before money is passed on.
This might feel counterintuitive but has a practical advantage: it avoids your children needing to find cash elsewhere.
Once the tax is deducted, your beneficiaries take what is left. They will still pay income tax on the withdrawals, but only on the post-IHT amount.
Here, the beneficiary receives the full pension value and pays the IHT from their own money.
This gives maximum flexibility, but it assumes they have funds available and are willing to take on the paperwork.
For high net worth families with multiple beneficiaries and complex assets, this route can be messy if expectations are not clear.
Interestingly, the rules are designed so that the outcome is broadly tax neutral.
In other words, no option is designed to be a loophole.
The difference is not the eventual tax owed but the administration, the timing, and the cash flow.
And for families who have lived through probate before, those three things matter.
No. Here are the three clarifications people often miss:
A traditional company DB plan has different rules.
Unused pots are the issue.
Most commentary focuses on UK regulated schemes.
For many families, the fear is greater than the reality. Most people will not have enough in pensions to create a large IHT problem.
But if your assets are above £2,000,000 or you have a sizeable pension fund, a little planning now can prevent a messy situation later.
If your pension provider has an old or vague nomination, fix it.
Trustees need clarity to distribute quickly.
Make sure they understand your preferences for how the IHT should be paid.
Surprises cause delays.
It may make sense to spend from ISAs or cash before tapping pensions.
A coordinated plan is always better than a reactive plan.
If everything passes to a spouse, there is no IHT, but planning ahead still matters for the surviving spouse’s estate.
When rules change, most people assume their adviser is up to date.
The truth is many advisers offer investment management, not estate planning.
Pensions and IHT require strategy, not sales.
Understanding IHT on pensions is not just a technical exercise.
It is one of the few decisions that can genuinely protect your family from an unnecessary tax bill.
If you want to explore how these rules apply to your situation, you can ask Evoa, our Wealth Coach Concierge, or arrange a conversation with us.
Nic Round is a Chartered Financial Planner and Chartered Wealth Manager, authorised and regulated by the Financial Conduct Authority.