An incoming change to the way pensions will be taxed when they’re inherited might mean you’re rethinking how you use your pension. Before you dive into updating your retirement plan, it’s important to understand what the changes could mean for you and how to balance passing on wealth with your retirement aspirations.
During the Autumn Budget in October 2024, chancellor Rachel Reeves announced that from April 2027 unspent pensions are likely to be included in Inheritance Tax (IHT) calculations. The government predicts the move will affect around 8% of estates each year.
In 2025/26, if the value of your entire estate is below £325,000, no IHT will be due. This is known as the “nil-rate band”. In addition, if you leave your main home to direct descendants, you may also benefit from the residence nil-rate band, which is £175,000 in 2025/26. Both thresholds are frozen until April 2030.
Your estate covers all your assets, such as property, savings, and material items. Currently, pensions fall outside of your estate, but you may want to consider how the value might change once pensions are included ahead of the new rule in 2027. Reviewing your retirement and estate plan could help you identify ways to improve long-term tax efficiency.
According to a February 2025 survey from interactive investor, 54% of UK adults are already planning to adjust their retirement or estate plan in response to IHT changes.
3 ways you might adjust your retirement plan to reflect Inheritance Tax changes
If the inclusion of your pension in your estate could increase the amount of IHT due, you might decide to update your retirement plan. Here are three options you could consider.
1. Spend more in retirement
The IHT changes could provide an excellent opportunity to update your retirement plan and consider what’s possible. Spending more of your pension during your life may bring the value of your estate under IHT thresholds or reduce a potential bill.
In the interactive investor survey, 19% of respondents said they plan to withdraw more money from their pension and gifting it (more on this later). What’s more, 6% are thinking about retiring earlier than previously planned.
So, if you want to deplete your pension during your lifetime, rather than leaving it as an inheritance, what would you do? You might start to think about a once-in-a-lifetime trip or how an income boost could allow you to do more of the things you enjoy, whether that’s visiting the theatre, supporting good causes, or keeping active.
Of course, spending more often needs to be balanced with long-term sustainability. A financial plan could help you understand if increasing pension withdrawals in retirement may lead to you running out of money later in life.
One thing to keep in mind is how increasing pension withdrawals could increase your Income Tax liability in retirement.
Your pension withdrawals will be added to other sources of income when calculating your Income Tax bill. As a result, taking a higher income from your pension could unexpectedly push you into a higher tax bracket.
2. Use your pension to gift wealth to your loved ones
If you’d previously planned to leave your pension to loved ones as an inheritance, gifting during your lifetime could provide a solution. You might withdraw a regular income or a lump sum to pass on to your beneficiaries.
A gift during your lifetime could be more beneficial to your loved ones than an inheritance later in life. It may allow them to purchase their first home, get married, pay education fees, or simply improve their day-to-day finances.
When gifting wealth, you may need to consider the “seven-year rule”. If you pass on assets and die within seven years of the gift being given, the asset could be included in your estate for IHT purposes. So, gifting during your early years of retirement could make sense if your goal is to reduce a potential IHT bill.
Again, keep in mind that withdrawing lump sums from your pension might increase your Income Tax liability and that gifting could affect your long-term financial security.
3. Reduce your pension contributions
8% of participants in the interactive investor survey suggested they planned to cut pension contributions due to the IHT changes.
For some people, this might be the right decision. For example, if you’ve already built up enough pension wealth to support yourself throughout retirement and you’d like to divert your money to other assets you could pass on tax-efficiently. However, it’s important to carefully assess your options to prevent knee-jerk decisions.
While your unspent retirement savings could become liable for IHT when you pass away, pensions are often tax-efficient in other ways. For instance:
- Your pension contributions will typically benefit from tax relief
- You can normally withdraw 25% of your pension (up to £268,275) tax-free
- Returns generated from investments held in your pension are not usually liable for Capital Gains Tax.
So, while your pension’s value may affect your estate’s IHT liability, maintaining, or even increasing, pension contributions could be tax-efficient when you look at them in the context of your wider financial plan.
Get in touch to talk about your pension and estate plan
If the incoming changes mean you’re unsure how to manage your pension or pass on wealth to loved ones, please get in touch. We can work with you to create or adjust a tailored financial plan that considers your circumstances and goals as well as regulation.
Please note: This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate estate planning or Inheritance Tax planning
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