ARE PENSIONS SUBJECT TO INHERITANCE TAX?

Defined benefit pensions follow different rules

There are pensions that will specifically pay the pension benefits to the deceased estate (Section 226, Annuity guarantees or value protections to name a few) and therefore, these will then be included in any inheritance tax calculation. For any defined benefit pensions that have been accessed due to serious health and the pension member dies within 2 years can have their pension benefits assessed for Inheritance tax by HMRC. The personal representatives will need to communicate with HMRC.

Pensions based on final‐salary or defined benefit schemes can provide dependents a lump sum or regular income. Most of these payments avoid Inheritance Tax, as trustees have discretion. However some lump sums may be taxed depending on the scheme’s structure and your age when you die. Some schemes offer lump sums that could count toward your estate in the future so it’s important to check with your provider.

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Nominate your beneficiaries and keep it updated

In most UK pension schemes, your expression of wish (or nomination) form guides the trustees or scheme administrators on who should receive your pension death benefits. If no beneficiaries are nominated, trustees must use their discretion to decide who gets the funds, usually by investigating your personal circumstances and relationships.

The nomination form (also called an expression of wishes) serves two key purposes:

• To tell the scheme administrator how you’d like your death benefits to be split among your chosen beneficiaries.
  
  
• To nominate a beneficiary for nominee flexi-access drawdown pensions and savings (known as a nominee). This is important because a scheme administrator can only offer beneficiary drawdown to a dependent, nominee, or successor.
  

Without a nomination or with an out-of-date one  there’s a risk that death benefits could be paid to people you wouldn’t have chosen and your beneficiaries might not be offered the option of beneficiary drawdown or an annuity. If your wish is for non-dependent children to have the option of flexi-access drawdown, you must nominate them specifically.

With this in mind, keeping your nomination up to date is essential, especially when your personal circumstances change. The majority of schemes make it quick and easy to update your beneficiary details, many of which can be done online.. 

Action: Complete your “expression of wish” form and update it after life changes such as:

• Marriage or divorce

• Having children

• A death in the family

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What is the threshold for inheritance tax?

Until 2023, there was a cap on how much you could hold in a pension without incurring additional tax. This cap, known as the Lifetime Allowance, has now been scrapped. However, from April 2027, new rules will mean that any unused pension funds and death benefits will be included in your estate when calculating IHT, even if your pension scheme has discretion over who receives the money.

This change means more estates could face a tax bill, and some may pay more than they would have under the old system. In fact, the government estimates that around 10,500 estates will now have to pay IHT when they wouldn’t have before and about 38,500 estates will pay more tax than they would have under the previous rules.

Currently, the standard IHT rate is 40% on the value of an estate that exceeds the Nil Rate Band (NRB), which for the 2025/26 tax year is £325,000. In addition, the Residence Nil Rate Band (RNRB) can increase your IHT threshold by £175,000 if you leave your main residence to direct descendants (including children, stepchildren, adopted or foster children, or grandchildren). When combined, the NRB and RNRB can provide a total threshold of up to £500,000 per individual. For married couples or civil partners, any unused NRB and/or RNRB can be transferred to the surviving partner upon death. This means that a combined threshold of up to £1 million could potentially be applied to the estate of the surviving spouse or civil partner.  However, if your estate if over £2m then you will start to lose the RNRB, for every £2 over the threshold you will lose £1 of the RNRB. 

Scenario: 

If a pension inclusive estate is valued at £1,350,000 and only £1 million is exempt, £350,000 would be taxed resulting in a £140,000 IHT bill. It is important to stay informed with the value of your assets especially as these generally grow over time. For further information please refer to GOV.UK and Quilter. 

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Pensions can help reduce your tax bill

Unlike savings or property, pensions haven’t usually triggered Inheritance Tax. That makes them useful for estate planning. Pensions can help reduce your tax bill by allowing you to save for retirement in a highly tax-efficient way. When you contribute to a pension, you will receive tax relief based on your marginal tax rate –  20% if a basic rate taxpayer, 40% for higher rate or 45% for additional rate. Depending on your circumstances and how you pay into pension will impact how the tax relief works. 

This strategy for avoiding Inheritance tax may be less useful after 2027 as cited in (4. What is the threshold for inheritance tax?)  so you will need to reassess as the rules change. 

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Key questions to consider

IYour pension isn’t just for you. With the right planning, it could be the most tax-efficient asset you leave behind.

Ask yourself:

• Have you nominated your pension beneficiaries?
• Have you valued your estate?
• Do your loved ones know what to expect?
• Are you drawing from the right sources in retirement?
• How will the new rules in April 2027 impact your loved ones?
  

This article was accurate as of August 2025. However, as shown regulations can and will change, so it’s important to seek professional financial advice to stay informed. At Astute Financial Planning, I provide up-to-date information and personalised guidance to help you make the most of your pension for both yourself and your loved ones. Please get in touch to find out more.

Tax Planning is not regulated by the Financial Conduct Authority

Sources: GOV.UK, Quilter