Since the autumn budget in October 2024, the press has been full of news about pensions falling into the estate for inheritance tax purposes.
The purpose of this article is to give you an update on the recent consultation paper that was released in July 2025, and explain some things that you should be thinking about with regards to your own pensions and estate so that you can understand the changes and what it means for you going forward.
The Basics
Let’s start with the basics so that we’re all on the same page; each individual has a nil rate band of £325,000. This is the amount that you can pass down to your loved ones that will not be subject to inheritance tax. Currently you also have a resident nil rate band of £175,000. This applies if you own a residential property and you are planning on leaving the property or money from the sale of the property to your direct descendants.
This gives an individual £500,000 worth of allowances you can offset against your estate, or £1 million for a couple. The nil rate and residence nil rate bands can be passed between couples on death. It goes without saying that you should consider leaving your pension to your spouse from April 2027, as doing this means it will not be liable for an inheritance tax charge at that point.
A couple of other things to think about, because it will become relevant as we go through is that the payment deadline for inheritance tax is six months after the end of the month in which death occurs. This means that you need to think about the impact that this could have when you’re dealing with pension providers going forward.
What Else?
In the consultation paper they confirmed that the current pension death benefit rules remain unchanged. This means that should you die before the age of 75 you can leave your pension income tax-free to your loved ones. This means that if they inherit some of your pension fund then they do not have to pay income tax when they take it out either as a lump sum or income.
If you die after 75 then any income that they take from your pension will be taxed at their marginal rate of tax. Which is why we tend to see younger people hold onto dependent pensions until they’re ready to retire themselves to avoid taking it out while they are still working and pay a higher amount of income tax.
The coming changes means that there will be an increased focus on death benefit nomination forms going forward as we try to ensure we minimise the implications of inheritance tax. Therefore, I would recommend reviewing yours as the pension changes approach to ensure maximum tax efficiency.
Pensions, What's Changing?
As mentioned from April 2027 defined contribution pension funds will now fall into your estate when calculating your overall tax liability. There have been a lot of complexities when trying to manage this change which is why it is taking so long for it to come into effect.
What will happen is that on death a personal representative will need to liaise with the pension scheme administrators to arrange for the inheritance tax on the pension to be paid. It is down to the personal representative to decide how the current nil rate band is portioned out between pension and non-pension assets.
There will be a calculator provided by HMRC to help this process and, at the moment, it looks as though the only inheritance tax that can be paid from the pension is the tax due in relation to that actual pension. Therefore, any other inheritance tax due will have to be paid from the other assets within the estate. Although this will bring its own challenges, especially when liaising with the pension providers, there are other things that need to be considered. Such as liquidity within the pension fund.
If the pension fund holds property this could be problematic as it would mean that the property would need to be sold before the inheritance tax could be paid, or the inheritance tax would have to be paid out of other assets. As a side note, this should be considered when you are deciding whether to consolidate your pension funds because then your personal representatives would have less pension providers to deal with.
How Many People Will be Affected?
Implications and What They Mean
We are probably seeing a change in the mentality of ‘fill it first and use it last’ when it comes to pensions. Historically, we have encouraged clients to use the other investments within their estate before drawing from their pension. This was because the pension would have been outside their estate for inheritance tax. Now that this is no longer the case, we are seeing an increase in clients actively looking to pull money out of pension, where it makes sense to do so. Especially as pension withdrawals are classed as income and therefore can be used as part of the gift out of income exemption. Meaning it could be more beneficial to take pension withdrawals and pay 20% income tax up to the higher rate threshold, than it staying in the pension and being taxed at 40% at a later date under the inheritance tax rules. Although this does only work if you spend the pension income taken or give it away. There is no point taking it and keeping it in your estate as then you would pay 20% on taking it out and then a further 40% on death.
Please remember that death benefits are not changing. If death occurs after 75 income tax will still be payable on the pension benefits when taken by a dependant. It has been confirmed that income tax will not be payable on the part that is used to pay the inheritance tax bill thus avoiding a double taxation on that element.
Further Unexpected Considerations
Pensions coming into the estate will most likely affect a segment of the population which probably don’t currently have an inheritance tax concern. Especially the younger generation who have built up good pension benefits but are likely quite highly mortgaged and with young children. You could look at this now and say there is no inheritance tax liability. However, should anything happen to them both with pensions falling into the estate that could change. Therefore, it could lead to an unfair tax bill on potentially quite a young family which could cause financial detriment for the surviving children.
Pensions falling into their estate will undoubtedly complicate the probate process since probate cannot be released until inheritance tax has been paid. This means we need to consider the impact of the release of the pension assets to pay the bill for this process. Where possible look at alternatives to mitigate inheritance tax going forward and ensure that the personal representatives know the plan so everything can go as smoothly as possible.
So, What Can We Do About It?
There are several areas of advice that we are talking to clients about that will continue to develop as the rules come into play, such as getting married. With spousal transfer of inheritance tax being available, and the joint nil rate band for a married couple, long-term partners who have not walked down the aisle might want to consider doing so for inheritance tax purposes.
It does question whether it’s right to leave the tax-free cash payment within a pension plan depending of course on individual circumstances. If it is not being used to create a tax efficient income consideration should be given as to whether that asset can be used elsewhere and if there is merit in taking it out and gifting it rather than it staying inside your estate and being liable for 40% tax
I’ve already spoken about using income tax allowances up to the high-rate threshold of £50,271 and gifting the income away. If going down this route consideration also needs to be given to the other income that the individual is receiving. This includes savings interest which is no longer taxed at source. It’s likely to lead to further consideration of other assets outside of the pensions as we rely more heavily on pensions providing income in retirement now. It’s also likely that we will see an increase in gifts thanks to the seven-year rule, which remained unchanged in the Autumn Budget.
Protections
It also makes our cash flow planning even more important as we try to mitigate as much inheritance tax as possible. One of the ways to do this is through utilising protection plans. Such as whole of life policies and term assurance. Whole of Life policies can traditionally be quite expensive however we can achieve a balance by using a decrease in term plan alongside, with the income from the pension or the growth on the assets being used to pay for the premiums.
The benefit of a whole of life plan means that if it’s written to trust not only are the premiums potentially inheritance tax free as they deemed to be a gift out of income, but also it will mean that that money will be readily available to pay the inheritance tax bill and therefore probate will not have to be delayed any longer than necessary. It may also help to minimise the interactions with the pension scheme providers.
Although it feels like we’ve been dealt quite a blow with the pensions coming into the estate, there are always options that we can investigate to mitigate Inheritance Tax for clients. I would encourage you, if you’re concerned about this, to reach out to us and we can discuss your personal situation further.
The Support You Need, When You Need It
The team at Bigmores Financial Planning is here to help you. If you’re uncertain about what is best for you once these changes take place, reach out to the team at Bigmores. Our People First ethos ensures we are putting your needs and wants first. For a free initial consultation, fill out the contact form below.
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