Don’t Fear the Reaper: Your Pension and Inheritance Tax from 2027

“Don’t fear the reaper… fear the tax man” – how your pension pot will soon be on the tax man’s radar.

Adam Davey is an independent financial advisor working for Rite Wealth Ltd in Glasgow. All views are his own and do not constitute financial advice. You can contact Adam at [email protected]

Benjamin Franklin once wrote, “In this world nothing can be said to be certain, except death and taxes”.

And in the Autumn budget of 2024, Rachel Reeves really took these words to heart when she announced that as of April 2027, pension pots would now fall in to an individuals estate for inheritance tax purposes.

For my first article of 2026, I thought that I would try and explain the basics of how inheritance tax works, what can be done to help ease an individuals liability and how Rachel Reeves plans for pensions, are going to bring a lot more people in to the scope of paying tax on their death.

Just before I start, it would be remiss of me not to stress that not all “pensions” will fall in to this new regime – pensions in payment from final salary schemes or pension annuities, are the two most common examples that won’t.

However, the majority of pension pots that are still invested for future income, will fall in to the inheritance tax (IHT) trap.

As with all financial planning matters, individual circumstances vary and there is not usually a one size fits all solution.

So, what does this mean for the general public?

To understand this, you must first of all understand how IHT works. Here is a very basic overview;

Everyone has their own personal allowance of £325,000. This means that they can leave this amount of assets to anyone before any IHT is applied. This is known as the Nil Rate Band.

There is also an additional allowance of £175,000 that can be claimed if you are leaving your residence to a direct descendant. This is known as the Residence Nil Rate Band.

Monies left to a surviving spouse are tax free and do not use up these allowances. If they are not used, they can be transferred to the surviving spouse.

If we used this transfer in an example of Mr & Mrs Smith, if Mr Smith left everything to Mrs Smith on his death, Mrs Smith could potentially have both her own and Mr Smith’s nil rate bands of £325k and £175k respectively to utilise on her death, giving a total of £1m in tax free allowances.

There are other caveats and intricacies to all of this but the main thing to remember, is that not everything is taxed, only the monies that fall over these nil rate bands.

Anything over these nil rate bands is taxed at 40%.

Let’s put some numbers on the above to illustrate how the tax works.

Mr and Mrs Smith have £1.5m in assets (with the property as part of this).

Neither of the nil rate band allowances had been used on Mr Smith’s death, meaning that when Mrs Smith passes, the first £1m would not incur any IHT.

However, the remaining £500k would be taxed at 40% creating a IHT bill for the estate of £200k.

What does this mean for pensions?

Well as stated at the start of the article, from April 2027, your pension pot could form part of your estate.

If we were to use the above example of Mr and Mrs Smith, we have already established that they have a £200k tax bill. If we now add in a pension pot, every penny of the pension will be taxed at 40%, as all of the permissible allowances have already been used.

And on top of this, the Residence Nil Rate allowance is means tested and starts to reduce for estates over £2m and is completely lost for estates at £2.35m.

These figures may seem huge but with the way property prices have risen and how the average pension pot is now much larger than in previous years, more and more people will be being dragged in to a IHT timebomb.

So how do I solve this problem?

The solution to this is to act sooner rather than later. Most IHT planning, usually involves an element of a ticking clock – the sooner actions are made, the easier it is to potentially reduce your IHT liability.

The main tool in all of this is to take stock of your assets and make a plan in conjunction with a solicitor and independent financial advisor.

Making sure your will is up to date, is the very first step.

Inheritance planning is an extremely complex topic, that can be managed, given enough time. The hardest part is to start the conversation, as no one likes to think about their own mortality or any of their loved ones dying.

However, the best way that I can explain it and how I always explain it to my clients – would you rather your money goes to your loved ones or to the tax man?