Inheritance Tax on UK Pensions from April 2027: What You Need to Know

For decades, UK pension funds sat outside the inheritance tax (IHT) estate entirely. An individual could accumulate millions in a SIPP or other defined contribution pension, nominate any beneficiary, and those funds would pass free of IHT on death. This made pension pots one of the most powerful IHT planning tools available — particularly after the Pension Freedoms reforms of 2015 made flexible access the norm and encouraged people to use other assets first and leave the pension intact.

That will change from April 2027. Following the October 2024 Budget announcement by Chancellor Rachel Reeves, unused pension funds and lump-sum death benefits will be brought within the scope of UK IHT from 6 April 2027.

This is one of the most consequential pension planning changes in a generation. It affects everyone with a UK pension pot — including non-UK residents who retain UK defined contribution or defined benefit pension arrangements.

What Is Changing

Currently, defined contribution pension pots (SIPPs, personal pensions, stakeholder pensions, most workplace DC schemes) are completely excluded from the IHT estate. They pass to nominated beneficiaries free of IHT, regardless of the size of the pot. Income drawn from the pot by the beneficiary may be taxable as income, but the pension itself does not trigger IHT on death.

From April 2027, unused pension funds will be added to the rest of the estate. The combined value of the estate (assets minus liabilities, including the pension) will be used to calculate the IHT liability. The nil-rate band (currently £325,000) and the residence nil-rate band (up to £175,000 for a main residence passing to direct descendants) will apply to the combined estate, but the pension value will be counted in determining whether and at what amount IHT is payable.

At the standard 40% IHT rate, a £500,000 pension pot in an otherwise IHT-liable estate generates a potential additional IHT charge of £200,000. For those with large pension pots and significant other assets, the combined IHT charge on death could be very substantial.

The Administration Mechanism

HMRC consulted on the mechanism for collecting IHT on pension funds in 2024-2025. The proposed approach requires pension scheme administrators to pay any IHT attributable to the pension fund directly to HMRC before paying the remainder to the nominated beneficiary. This places the reporting and payment obligation partly on the pension scheme rather than entirely on the executors of the estate.

The interaction between IHT on pension death benefits and income tax on pension income remains complex. Where a beneficiary inherits a pension fund and subsequently draws from it, they pay income tax on those drawings — there is a risk of the same underlying funds being subject to both IHT (at death) and income tax (on subsequent withdrawal). HMRC has indicated that some adjustment will be made for this double charge, but the precise mechanism is still being confirmed.

Who Is Most Affected

Large SIPP holders who have not drawn from the pension. The entire point of the original IHT exemption was to encourage pension pots to be used for retirement income. Many individuals — particularly those with other income sources (rental income, business income, other investments) — treated their pension as an inheritance vehicle rather than a retirement income source. These individuals need to reassess their strategy.

Non-UK residents with UK pension pots. A British national living in Dubai or Cyprus who has a £750,000 SIPP accumulated from their working career in the UK, and who has not needed to draw from it because they have other income, now faces a significant IHT charge on that pension on death. The non-UK residence does not provide any protection from UK IHT on UK pension assets.

Younger people who inherited pension funds under the old rules. The "beneficiary fund" — where a nominated beneficiary inherits a pension and can continue to hold it within a pension wrapper — is also likely to be affected by the new rules, though the detail is still being confirmed.

Those approaching the Long-Term Resident threshold. As set out elsewhere, the LTR test for IHT purposes catches individuals who have been UK-resident for 10 out of 20 years on worldwide assets. A non-UK resident approaching this threshold who also has a large UK pension needs to consider the combined effect: LTR exposure on worldwide assets plus pension inclusion from April 2027.

What Is Not Changing

Defined benefit (final salary) pensions. Most defined benefit schemes pay a spousal pension on death rather than a lump sum pot. The IHT change is primarily targeted at defined contribution funds. Defined benefit pensions that pay pension income to a surviving spouse typically fall outside the IHT estate under the new rules — though the position of lump-sum death benefits from DB schemes is being considered.

Crystallised pension funds already in drawdown. Funds that have been crystallised (i.e., moved from uncrystallised status into income drawdown) and are already being drawn are not a separate "pot" in the same sense. The IHT treatment of drawdown funds versus uncrystallised funds is a technical area still being confirmed.

Nominated beneficiary designation. The process of nominating a beneficiary for your pension continues to be important. The nomination does not prevent IHT (under the new rules) but it does determine who receives the remaining proceeds after the IHT charge is paid.

Planning Responses

Start Drawing From the Pension

The simplest response is to begin drawing from the pension earlier than you might otherwise have done. Money withdrawn from a pension and moved outside the pension wrapper (into an ISA, an offshore bond, or used for expenditure) reduces the pension pot that will be subject to IHT.

For non-residents, drawing from the pension has tax implications in the country of residence. UK pension income paid to a non-resident is generally taxable in the UK (under PAYE or via self-assessment) with credits available under the relevant DTA. In the UAE, there is no local income tax so the UK tax is the only charge. In Cyprus, the non-dom favourable rate for pension income may apply.

QROPS Transfer for Permanently Non-Resident Individuals

A Qualifying Recognised Overseas Pension Scheme (QROPS) transfer moves the pension out of the UK pension framework entirely. For a permanently non-resident individual who has no intention of returning to the UK, a QROPS transfer can remove the pension from the UK IHT estate.

Key conditions and charges for QROPS transfers:

• A 25% Overseas Transfer Charge (OTC) applies on transfer unless an exemption applies. As of 30 October 2024, HMRC abolished the EEA/Gibraltar exemption — the only remaining exemption from the OTC is where both the member and the receiving scheme are in the same country at the time of transfer. If you live in Malta and transfer to a Maltese QROPS, no OTC arises; if you live in the UAE and transfer to a Malta QROPS, the 25% charge applies.
• You must have been non-UK resident for more than five complete tax years (or intend to be) — a further OTC arises if you transfer and return to the UK within 5 years.
• The receiving scheme must be a recognised QROPS; HMRC publishes a current list.
• You must take advice from a qualified adviser.

The QROPS market has contracted significantly since HMRC tightened the rules in 2017 and again in subsequent years, and the October 2024 OTC changes narrowed it further. Not all foreign pension schemes remain qualifying. The costs and suitability of a QROPS transfer need careful analysis — it is not appropriate for everyone, and the OTC position must be assessed in detail before proceeding.

Accelerated Gifting from Pension Income

Once in drawdown, pension income can be gifted to reduce the overall estate. The £3,000 annual exemption, regular gifts from surplus income (which fall outside the estate immediately if genuinely made from income), and seven-year PETs can all be used to transfer wealth from the pension income stream to the next generation.

Life Insurance in Trust

Some individuals fund a whole of life insurance policy — written in trust — to cover the expected IHT liability on the pension. The policy pays out on death, the trustees pay the IHT bill, and the pension value passes to the beneficiary (less the IHT charge). The premium cost is effectively the "price" of IHT insurance.

This approach does not reduce the IHT; it funds it. But it can be useful where the pension pot is illiquid or where the beneficiaries would prefer certainty about the net amount they will receive.

The Urgency of Acting Before April 2027

April 2027 is closer than it may appear. A QROPS transfer, even if initiated now, takes several months to complete. Pension drawdown strategies need to be set up with the administrator and HMRC. IHT planning that involves trusts or gifts needs time to work.

The window between now and April 2027 is the period of maximum planning flexibility. After April 2027, the options narrow to managing an IHT liability that already exists, rather than preventing it.

How Global Investments Can Help

The IHT on pensions change represents one of the most significant prompts to pension planning review in decades. Global Investments works with clients to model the impact of the April 2027 change on their specific pension position, assess whether QROPS transfer is appropriate, and develop a drawdown and gifting strategy that manages the IHT exposure on the pension alongside the broader estate.

For non-UK residents with UK pension pots, we coordinate with UK pension specialists and cross-border tax advisers to ensure the planning is appropriate for your country of residence as well as your UK tax position.

This article is for general information purposes only and does not constitute personal tax, pension, or financial advice. The rules described are subject to confirmation and may change before April 2027. Please seek qualified professional advice before taking any action.