With the Finance Bill 2026 looming, Cally Terkelsen, a Trainee Solicitor in the Private Client team at Knights, looks at the potential implications of new tax rules on pension pots.
For years, employees have been encouraged to maximise their pension pots, both for purposes of ensuring financial security for their own retirement, and for providing dependents with capital out of any unused pension funds when the pension holders pass. From April 2027, this entrenched message of ‘save save save’ is set to turn on its head. Gone are the days of risk-free large pension pots.
From 6 April 2027 onwards, any unused pension funds will be included in a deceased person’s estate for Inheritance Tax (IHT) purposes. The new position will require Personal Representatives (PRs) to notify the pension schemes of a member’s death, and the scheme administrators will be obliged to share the value of unused pension funds within 4 weeks of the notification. If the value of the estate (inclusive of the pension funds) falls above the nil rate band, PRs will be required to pay IHT on the pensions within six months.
Like the rationale behind other new inheritance tax initiatives, HMRC want to mitigate the risk of pensions being used as mechanisms for tax-avoidance. But is this really the case? Most individuals have little involvement in setting up their pension yet are encouraged to contribute large amounts to their pension in order to secure a comfortable retirement. Most do not intend to use their pensions as a means of tax avoidance.
Firstly, no need to panic if you are married or in a civil partnership… for now. Like the majority of inheritance tax exemptions, transferring pension funds to a spouse or civil partner will remain free of IHT. For those who have already lost their spouse, or are a single parent, it may be more difficult, and legal advice is recommended. Beneficiaries who are required to pay IHT may also be hit with income tax if they are receiving income from the inherited pension. In particular, young families who experience bereavement will be disproportionately affected. Providing for financial dependents is one of the crucial purposes of building up a pension pot. Notably, with the changes set to affect defined contribution pension schemes the most, the new burdens of this change will fall almost exclusively on defined contribution members’ families. In what is already a financially and emotionally fragile time, young families may not be able depend on this once-reliable source of income post-bereavement.
Implement a Trust to hold your pension funds in order to keep spouse’s estate low. Ensure to seek advice as there could be other taxation consequences
Withdraw up to 25% of your pension pot, if not reliant on its income, tax free, and make gifts (but beware of the seven years rule!)
Make gifts out of surplus income, and be sure to keep a record
Perhaps less fitting with the status quo, spend your money!
The Government does state that of all the taxpaying estates affected by these reforms, the pension component makes up less than 5% of the net value of the estate in more than half of all cases in the year 2027-2028. However, for those affected, this will mandate a huge administrative burden for both PRs dealing with the payment of IHT and those scheme administrators who are on a tight deadline to provide the value of the pension for IHT purposes, as well as to inform beneficiaries whether they are exempt or not.
With the Finance Bill 2026 looming, solicitors must be vigilant in their estate planning advice, and pension holders must draw a fine line… have a comfortable retirement or risk passing a large inheritance tax bill on your dependents?
