Pensions, Inheritance Tax and the Danger of Playing Yesterday's Game

For years, pensions have occupied a curious position in financial planning.

They were designed to help fund retirement. Yet for many families, particularly those fortunate enough not to need all of their pension wealth, they evolved into something else entirely: one of the most effective inheritance tax planning vehicles available.

It wasn't an accident.

Financial planners, tax specialists and informed investors all arrived at the same conclusion. If pension assets sat outside your estate for inheritance tax purposes, why spend them first? Why not spend assets already exposed to inheritance tax, such as cash, ISAs and general investment accounts, and leave the pension untouched for as long as possible?

It became a widely accepted strategy. In many cases, a very sensible one.

But there is a danger in any strategy that works for too long.

We begin to assume the rules are permanent.

They rarely are.

From 6 April 2027, unused defined contribution pensions and most lump sum death benefits will be brought into the inheritance tax net. For many households, this represents one of the most significant planning changes of the past decade.

And it serves as a useful reminder that successful planning is not about finding a perfect strategy. It is about continually adapting as circumstances change.

The Hidden Risk of Success

There is an idea in performance psychology known as "success bias".

When something works, we naturally assume it will continue working. The longer it works, the stronger that belief becomes.

In sport, businesses and investing, this can be dangerous.

The world changes while we continue using the playbook that succeeded yesterday.

The pension inheritance tax changes are a good example.

For years, many affluent households have deliberately preserved pension wealth while drawing from other assets first. The logic was compelling. Pension funds sat outside the estate. ISAs and investment accounts did not.

But from April 2027, the calculation changes.

Pension wealth will no longer enjoy that same protection.

The strategy that was optimal yesterday may not be optimal tomorrow.

That doesn't mean it was wrong.

It simply means the environment has changed.

What Is Actually Changing?

Under the current rules, unused defined contribution pension funds are generally excluded from inheritance tax calculations.

If someone dies before age 75, beneficiaries can usually receive the pension entirely free of tax.

If death occurs after age 75, beneficiaries pay income tax as they draw the funds, but there is still no inheritance tax charge.

From 6 April 2027, that position changes.

Unused pension funds will generally be included when HMRC calculates the value of an estate.

Where the estate exceeds the available allowances, inheritance tax may be payable at 40%.

The pension can still pass to beneficiaries, but the tax bill may need to be settled first.

A number of important exemptions remain.

Assets passing to a surviving spouse or civil partner remain exempt from inheritance tax.

Charitable gifts remain exempt.

Death-in-service benefits from registered pension schemes (a common life insurance policy from workplaces) have also been excluded from the new rules following consultation.

However, for many families who have accumulated substantial pension wealth over decades, the overall inheritance tax exposure could increase significantly.

Where the Real Impact Will Be Felt

The families most affected are often not those who consider themselves wealthy. They are the families who have done many of the right things for many years. They have paid off a mortgage.

Built pension savings.

Accumulated ISA investments.

Perhaps retained some money in general investment accounts.

Perhaps inherited assets from parents.

Nothing extraordinary.

Just decades of sensible financial behaviour to set themselves up for a more secure and comfortable retirement.

The challenge is that when pensions are added back into the calculation, estates can suddenly move into inheritance tax territory, or much deeper into it.

There is a particularly painful area around the £2 million threshold.

Many people are familiar with the residence nil-rate band, which can provide additional inheritance tax allowances for family homes.

What fewer people realise is that this allowance is gradually withdrawn once an estate exceeds £2 million.

The result is an effective marginal inheritance tax rate of 60% across part of the estate.

For some families, the inclusion of pension wealth could push them into exactly this territory.

That is not a small technical adjustment.

It can materially alter the outcome for future generations.

The Double Tax Problem

The position becomes even more interesting after age 75.

Before age 75, the primary issue is inheritance tax.

After age 75, beneficiaries may face both inheritance tax and income tax.

Imagine a higher-rate taxpayer inheriting pension wealth from a parent who dies after age 75.

First, inheritance tax may reduce the value of the pension.

Then, when the beneficiary draws the remaining money, they may pay income tax at 20%, 40% or 45%.

The combined effect can be substantial.

This is one reason why broad statements such as "leave the pension untouched" are becoming less reliable.

Context matters.

Age matters.

Family circumstances matter.

The tax position of beneficiaries matters.

The details matter.

The Flexibility Gap

There is another consequence of these changes that receives far less attention.

Traditionally, many families have relied on a degree of flexibility after death.

Circumstances change. Children may be in different financial positions than expected. Tax rules evolve. Assets may not need to pass exactly where they were originally intended.

Where assets pass under a will, beneficiaries can often use a Deed of Variation to redirect them within two years of death. This can create valuable flexibility where family circumstances or tax considerations suggest a different outcome would be beneficial.

Pension benefits do not generally offer the same level of flexibility.

Once pension trustees have exercised their discretion and benefits have been paid or designated, the opportunity to reshape the outcome can be far more limited. This was often less important when pension wealth sat outside the inheritance tax system. It becomes more relevant when pension assets are now part of the wider estate planning conversation.

The irony is that pensions are becoming more like estate planning assets from a tax perspective, while remaining less flexible than many traditional estate planning assets.

This makes pension nominations and expressions of wish more important than ever. A nomination completed many years ago may still reflect your wishes, but it may no longer produce the most efficient outcome under the post-2027 rules.

For many families, reviewing pension nominations should now sit alongside reviewing wills, powers of attorney and broader estate planning arrangements.

The Question Nobody Likes Asking

Perhaps the most important question is also the least comfortable.

What is the purpose of your pension?

For years, many people have treated pensions as inheritance assets that happen to provide retirement income.

But if we’re are being sincere, pensions were originally designed for retirement.

There is a growing possibility that some households may now benefit from using pension assets more actively during their lifetime.

Not necessarily spending them.

Simply using them differently.

For some families, drawing pension income and gifting surplus funds may prove more efficient.

For others, pension withdrawals may be redirected into ISAs there by avoiding the risk of post 75 income tax issues.

For some, life insurance written into trust may provide a useful solution where leaving a legacy is a higher priority.

For others, charitable giving may become more attractive.

There is no universal answer and each person’s situation is likely to be different.

The key point is that the question itself needs revisiting.

What Should You Avoid?

Whenever tax rules change, there is a temptation to act quickly.

That temptation should be resisted.

One of the worst reasons to withdraw money from a pension is simply because a future rule change exists.

Taking large withdrawals today could trigger unnecessary income tax.

Moving funds from a tax-efficient pension into cash held inside a taxable estate can actually leave a family worse off.

Even after the 2027 changes, pensions remain one of the most tax-efficient investment structures available and have a lot of positives to still being part of a growing financial plan.

The objective we’re looking at here is not to abandon pensions because they’ve lost their use.

The objective is to understand how they now fit into the wider retirement and estate planning picture.

That distinction matters.

The Planning Opportunity

There is a phrase often used in elite sport.

The best performers are not those who avoid change.

They are the ones who adapt to it fastest.

The same principle applies to financial planning.

The April 2027 changes do not mean previous planning was wrong…Far from it.

Those decisions were made using the right information available at the time.

What matters now is recognising that the environment has shifted and the original plan need to be reviewed.

For some families, very little will change and the plans they have in place will continue to work just fine.

For others, the impact could be significant and when they look ahead, it would be wise to reassess their plans.

The challenge is not predicting every future tax change – this is impossible. The challenge is building a personalised plan that can adapt when those changes arrive.

That has always been the real purpose of financial planning.

Not certainty.

Financial security and adaptability.

What We Are Doing With Clients

This is already a major focus of our planning discussions.

We are reviewing pension nominations and expressions of wish, modelling the impact of the new rules, assessing whether alternative inheritance planning opportunities may be appropriate more and considering whether current withdrawal strategies remain suitable.

Some clients will make changes.

Others will not.

In many cases, the most valuable outcome is simply understanding the options before decisions are made.

We are also spending more time discussing how pensions fit within a family's wider estate plan. Historically, pensions and estate planning could often be considered separately. From April 2027, that distinction becomes much harder to justify.

In many cases, we are also encouraging clients to review pension nominations alongside their wills, as it is increasingly important that both work together towards the same outcome.

If you would like to understand how these changes could affect your family, or if you know someone who may be impacted, please feel free to get in touch for an initial conversation.

Important Information

This article is intended as general information only and does not constitute financial, tax or legal advice. Before taking action, you should seek advice appropriate to your own circumstances.

The rules described above reflect the position under Finance Act 2026, which brings most unused pension funds and pension death benefits into the value of a person’s estate for inheritance tax purposes for deaths on or after 6 April 2027. HMRC guidance and supporting regulations are still expected before implementation.

Tax treatment depends on individual circumstances and may change in the future. The impact of these rules will vary depending on factors such as age, health, family circumstances, pension arrangements, estate value and the tax position of beneficiaries.

The value of investments and pension funds can fall as well as rise and you may get back less than was invested. The benefits of pension and inheritance tax planning are not guaranteed and will depend on future legislation and your personal circumstances.