Could your pension push your estate over the £2 million Inheritance Tax taper?

From April 2027, the way your pension interacts with Inheritance Tax (IHT) is set to change considerably.

Indeed, most unused pension funds and death benefits will form part of your estate for IHT purposes when you pass away.

Data reported by Which? states that the measure could leave approximately 10,500 estates facing IHT that otherwise wouldn’t have done so, while another 38,500 could pay more tax. The average increase among these affected estates is expected to be about £34,000.

If the value of your estate is already approaching £2 million, adding your unused pension could push you above the point where your residence nil-rate band starts to reduce.

This could leave more of your wider estate exposed to IHT.

With this in mind, continue reading to discover how the £2 million threshold works and why it may be worth reviewing your estate plan now, before the new rules come into effect.

Most unused pensions will count towards the value of your estate from April 2027

Under the current rules, many pension funds sit outside your estate for IHT purposes. This is all set to change for deaths on or after 6 April 2027.

The Finance Act 2026 will bring most unused pension funds and death benefits into the value of your estate, but there are some exceptions.

For instance, death-in-service benefits paid from registered schemes and certain dependants’ pensions will remain outside the new rules.

Transfers to an exempt beneficiary – such as a spouse or civil partner in qualifying circumstances – may also remain free from IHT.

However, if you intend to leave pension wealth to children or other beneficiaries, the value involved could now have a much greater effect on your estate plan.

The residence nil-rate band starts to taper once your estate exceeds £2 million

Most people in the UK have a standard IHT nil-rate band of £325,000. Moreover, if you leave your main home to a direct lineal descendant, such as a child or grandchild, you may also benefit from the £175,000 residence nil-rate band.

This can allow you to pass on up to £500,000 before IHT is due. Unused allowances can also transfer between spouses and civil partners. 

It’s vital to note that once your estate exceeds £2 million, you lose £1 of the residence nil-rate band for every £2 above the threshold.

So, if you had the full £175,000 available and your estate was worth £2.1 million, you would lose £50,000 of the allowance, leaving £125,000. 

By the time your estate reaches £2.35 million, you would effectively lose the full residence nil-rate band entirely. 

Importantly, the £2 million calculation looks at the value of your assets after debts and other liabilities, but before deducting exemptions and reliefs.

Your pension could push you above the threshold even if your estate currently sits below it

Imagine your estate, excluding your pension, is worth £1.9 million and you have the full £175,000 residence nil-rate band available.

Under current rules, a pension might sit outside your estate altogether.

Now, suppose you also have £300,000 of unused pension wealth when you pass away after April 2027.

Once you include that pension, your estate for IHT purposes would rise to £2.2 million, putting you £200,000 above the residence nil-rate band threshold.

In this instance, your available threshold would be reduced by £100,000 to just £75,000. 

As a result, the pension doesn’t simply add another £300,000 to your estate. It could also cause you to lose £100,000 of an allowance that might otherwise have protected part of your home from IHT.

The taper could also affect allowances you hope to pass to your spouse or civil partner

If you’re married or in a civil partnership, you may assume the £2 million threshold only matters when the second partner passes away. However, this isn’t always the case.

If the first person to die has an estate worth more than £2 million, tapering can reduce the amount of unused residence nil-rate band that can later transfer to the survivor. 

This can happen even if no residence nil-rate band was used following the first passing, for example because the home passed to a spouse or civil partner, which is why it’s vital to understand the value of both estates.

Once pensions enter the calculations from April 2027, you may find that your combined property, investments, and pension wealth place you closer to the taper threshold than you previously realised.

Reviewing your estate plan could help you understand the impacts of the changes

The upcoming pension changes don’t necessarily mean you should start withdrawing money to reduce the value of your pot.

If you do this and leave it sitting in a bank account, for instance, it will generally still form part of your estate.

Other options, such as gifting your wealth or changing how you draw income in retirement, can also have their own tax rules and could affect your long-term financial security.

That is why it can help to review your estate plan with a financial planner.

We can help you estimate the future value of your estate, including your pension, and show how crossing the £2 million threshold could affect the residence nil-rate band available to you.

This might help you understand whether the 2027 changes are likely to affect your estate and, if they are, what steps may be worth considering well before the rules come into effect.

To find out more, please email info@athertonyork.co.uk or call us on 0208 882 2979.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. 

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts. 

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.

The Financial Conduct Authority does not regulate estate planning or tax planning.