For a long time many people treated their pension as a quiet shelter from inheritance tax. It was the pot you did not touch unless you had to, the fund that could be passed on with relatively little tax friction, especially if death occurred before age seventy five. That picture is changing. With recent reforms and the planned shift from April 2027, pensions are becoming more closely tied to inheritance tax, so the way you use them over your lifetime needs to evolve as well.
At the same time as these inheritance changes, the old lifetime allowance has been abolished and replaced with new limits on how much can be taken tax free in lump sums. Instead of worrying about the total size of the pension fund, you now need to pay attention to how much tax free cash you take during life and on death, alongside the usual concerns about income tax on withdrawals. All of this means that pensions can no longer be seen only as a personal retirement pot and a convenient inheritance vehicle that sits outside the estate. They remain very tax efficient, but they now interact much more directly with inheritance tax and with the rest of your assets.
It helps to ground this in how inheritance tax works more generally. In broad terms, inheritance tax in the United Kingdom is charged at forty percent on the value of an estate above the available allowances. There is the basic nil rate band, there is the separate residence nil rate band for a main home left to direct descendants, and both sets of allowances can often be combined between spouses or civil partners. Many households will still fall below these thresholds, particularly if they do not own high value property or large investment portfolios, but more families are being drawn into the net as asset prices have risen while thresholds have been frozen.
Historically, most defined contribution pensions sat outside this calculation. Where scheme trustees had discretion over who received benefits, unused funds in a pension were normally not counted as part of the estate for inheritance tax purposes. Advisers often used a simple rule of thumb. They encouraged clients to spend from non pension assets first and to leave pensions untouched for as long as possible, using them as a last resort for income and as a flexible inheritance tool for the next generation.
From April 2027 that approach will no longer be sound for many people. The government has confirmed that most unused pension funds and many pension death benefits will be treated as part of the estate for inheritance tax. Personal representatives will be responsible for reporting the value and settling any tax due, rather than pensions sitting politely outside the calculation. Some familiar protections will remain. Transfers between spouses and civil partners should still benefit from the normal inheritance tax exemption. Death in service lump sums from registered workplace schemes will stay outside the scope, reflecting their nature as family protection rather than a deliberate tax planning device. However, the broad direction of travel is clear. Pensions are moving into the estate, not sitting apart from it.
This change matters most for people whose total wealth is already close to, or above, the available allowances. If your combined property, savings, investments and pensions are unlikely ever to breach the thresholds, the new rules will probably not change your day to day decisions. Your focus will still be on generating a secure income in retirement and keeping investment risk at a level you can live with. For households with larger estates, the interaction between pensions and inheritance tax becomes central, especially when combined with the age seventy five boundary that already shapes pension taxation.
Under the current system, death before seventy five typically allows beneficiaries to receive defined contribution pension funds without income tax, as long as payments are made within the required time and allowance limits. After seventy five, beneficiaries usually pay income tax at their own rate when they draw money from an inherited pension. Once inheritance tax is brought into the picture on unused pension funds, a difficult combination can arise. If someone dies after seventy five with a sizeable estate already in inheritance tax territory, their beneficiaries may face a charge on the value of the pension in the estate and then income tax when they eventually take withdrawals. The effective tax rate on inherited pension wealth can become very high, especially for beneficiaries who are themselves higher rate taxpayers.
All of this means that using pensions smartly in the new regime is less about discovering a clever loophole and more about changing the order and timing of how you draw from different pools of wealth. The first step is to be honest about what your pension is really for. Is it primarily intended to fund a long, comfortable retirement for you and a partner, or has it also become a deliberate inheritance planning tool for children or other beneficiaries? There is no right or wrong answer, but clarity matters.
If your main goal is secure income for yourself, you still need to build a plan that gives you enough to live the life you want. The difference now is that you should aim to do this in a way that does not accidentally enlarge your taxable estate in later life. That might mean reconsidering the old habit of ignoring the pension completely while you run down other assets, especially if those other assets are already inside the inheritance tax net. If you have more than enough income from property, business interests or non pension investments, and the pension is largely for your heirs, the question becomes subtler. You may still leave most of the pension invested, but you might choose to draw some income earlier than you otherwise would, in order to manage future inheritance exposure.
This leads naturally into a rethink of the order in which you spend from your different pots. The traditional advice to spend cash, general investments and sometimes even tax efficient accounts first, while preserving the pension at all costs, grew out of a world in which pensions were usually outside inheritance tax. As unused pensions move inside the estate, the gap narrows. Non pension assets may still be more exposed in some cases, but pensions can no longer be treated as completely separate. A more balanced approach might involve taking a modest, sustainable income from the pension earlier in retirement, particularly if your estate is already above the allowances, rather than leaving the fund to grow untouched.
One practical strategy is to use a combination of pension income and non pension gifts. Pension withdrawals provide the cash flow to support your lifestyle. Surplus non pension assets, which are fully inside the inheritance tax net, can then be given away in a measured way. Some gifts fall out of the estate immediately when they meet certain criteria, such as regular gifts from surplus income. Others become exempt if you survive seven years. By moving value gradually from taxable assets to the next generation during your lifetime, you may reduce the amount that ends up inside the estate when you die, including the pension portion.
The new lump sum allowances reinforce the case for planning in smaller, deliberate steps rather than relying on a single large event. Instead of a single lifetime allowance that capped the total size of your pension, there are now limits on how much tax free cash can be taken in lump sums during life and on death. Amounts above these limits are usually taxed as income. If you had intended to help children with a home deposit or to leave a large lump sum from the pension on death, you now need to map those intentions against these allowances. A series of well planned gifts, funded through a mixture of pension income and other resources, may prove smoother and more tax efficient than one large withdrawal that breaches the limits.
Even under the new rules the structure of your pension arrangements and your choice of beneficiaries still matter. Death in service benefits remain a valuable and tax efficient form of protection for younger families. In defined contribution pensions, nominations should be reviewed to make sure they reflect your current wishes. It can make a difference whether funds are paid as a lump sum to one person, allocated between several beneficiaries, or left in a beneficiary drawdown arrangement that allows income to be taken gradually over time. Spreading withdrawals may help keep beneficiaries in lower tax bands and avoid triggering higher rates unnecessarily, particularly if inheritance tax has already taken a slice at the estate level.
Certain situations require extra care. Blended families and second marriages often involve a desire to provide for a new partner during their lifetime while eventually passing capital to children from an earlier relationship. Pensions can still support these goals because they allow different beneficiaries to be chosen for different stages. Business owners and people with illiquid assets face another type of complexity. If more of your wealth is now within the inheritance tax calculation, you need a realistic plan for how any future tax bill would be paid. Pensions that once sat outside the estate may now form part of that funding solution, which is an additional reason not to leave them entirely untouched without thought.
For those who have built their careers abroad but still hold UK pension rights, or who live as expatriates in places like Singapore or Hong Kong, the picture is more complex again. The proposed changes affect UK registered schemes and some overseas arrangements that fall under UK rules, but withdrawals may also be taxed in the country of residence. Using pensions wisely in these circumstances usually requires coordinated advice so that steps taken to manage UK inheritance tax do not unintentionally trigger heavy local income taxes or create cash flow difficulties.
Despite the layers of technical detail, the way forward can be simplified into a practical frame of mind. Begin by clarifying your priorities for retirement and for family wealth. Map out your estate, including all major assets and existing life insurance. Decide whether it is likely to exceed inheritance tax thresholds under the present rules. If it is, consider bringing pension withdrawals into the plan earlier in a measured way, instead of treating the pension as a separate, untouchable reserve. Make sure your will, your pension nominations and any trust structures are aligned with these decisions, and ensure that the people who will handle your affairs understand that pensions are now part of the inheritance tax picture rather than something outside it.
Finally, it is worth accepting that tax policy can change again. The date set for the new rules, the frozen thresholds and even the shape of inheritance tax itself may be revisited by future governments. You cannot control this, but you can design a plan that is flexible and does not depend on a single fragile assumption. A calm review of your position with a qualified planner or tax specialist, focused on the interaction between pensions, other assets and likely inheritance tax, can turn a confusing rule change into a series of manageable decisions.
Seen this way, using pensions smartly under the updated inheritance tax rules is not about chasing the perfect tax result. It is about weaving your pension back into the centre of your financial life, making sure it supports your retirement, reflects your intentions for the people you care about, and fits sensibly within the rules as they stand today, while still allowing you room to adjust when life, markets or policy shift in the years ahead.
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