How to avoid the Inheritance Tax trap
The 2027 pension rule change could catch many families off guard. Here's what you need to know.
Inheritance Tax (IHT) used to be something only the very wealthy worried about. Not anymore. With house prices soaring and tax thresholds frozen since 2009, more ordinary families are getting caught in the IHT net.
And from April 2027, there's a major change that could affect even more people: pensions will no longer be exempt from IHT.
Understanding the current rules
Before we look at what's changing, it's important to understand the current IHT thresholds:
Basic allowance: Everyone gets a £325,000 nil-rate band
For married couples and civil partners: Any unused allowance can be transferred to the surviving spouse or civil partner, effectively doubling it to £650,000
Residence nil-rate band: An additional £175,000 is also available when leaving your main home to children or grandchildren. This can also be transferred to a spouse or civil partner, which creates a combined allowance of up to £1m.
It’s important to note that these valuable reliefs don't apply to unmarried partners, making estate planning even more crucial.
The big change coming in 2027
Right now, when you die, your pension pot doesn't count towards IHT. That's about to change.
From April 2027, any money left in your pension will be added to your estate and could be taxed at 40% if your total estate exceeds the threshold – even with the spousal reliefs above.
Here's a simple example:
Your house: £600,000
Savings and other assets: £200,000
Pension pot: £400,000
Total estate: £1,200,000
Currently, only £800,000 (house + savings) would count for IHT. From 2027, the full £400,000 would also count. This could potentially create a tax bill of £350,000 instead of £190,000 (see below).
Who will be affected?
The number of people who’ll be affected by this change will be huge: in 2021/22, there were around 27,800 estates paying IHT. By 2029/30, the Office for Budget Responsibility estimates that receipts will soar to £14.3 billion. That’s not just because the super-rich are getting richer - it’s because more middle-class families will be caught out.
You might be at risk if:
You have a substantial pension pot
You haven’t reviewed your estate planning recently
You’re unmarried partners (as you won’t qualify for spousal allowances)
The good news is there are ways to mitigate IHT. However, it can be quite complex and always depends on your own personal circumstances.
Four ways to protect your family
1. Start giving money away now
The easiest way to reduce your IHT bill is to give money away while you're alive. You can give:
£3,000 a year per person (plus any unused allowance from the year before)
Small gifts of £250 per person
Wedding gifts - £5,000 to children, £2,500 to grandchildren
Regular gifts from surplus income - as much as you like, as long as it doesn't affect your standard of living
If you give away larger amounts, they'll be tax-free if you survive seven years after making the gift.
2. Consider using your pension sooner
Since your pension will count towards IHT from 2027, you might want to start drawing from it earlier. But it’s a good idea to be strategic about this:
Spend it on things you enjoy - holidays, home improvements, experiences
Give it away as regular income if you don't need it
Don't just move it to your bank account - that's still part of your estate
3. Look into trusts
Trusts can be useful if you want to give money away but keep some control over how it's used. They're complex, so you'll need our advice, but they can be effective for larger gifts.
4. Make sure your affairs are in order
Update your will to reflect your wishes
Review your pension beneficiaries - make sure they're up to date
Keep records of any gifts you make
Talk to your family about your plans
Don't panic, but don't wait
While more families will be affected by these changes, many still won't pay IHT. The key is understanding your own situation and planning ahead.
Remember:
Your pension is still one of the most tax-efficient ways to save
These rules don't take effect until April 2027
You have time to plan and make changes
We can help you navigate the options
The bottom line
The 2027 IHT changes mean it's time to review your finances and consider your options. Whether that's giving money to family now, spending your pension more freely, or setting up trusts, the important thing is to start planning.
Don't let your family get caught in the IHT trap. Start the conversation now, understand your situation, and take action while you still can.
Give us a call if you’d like to know more about how we can help you reduce your IHT bill – we’re always happy to chat.