Pension savers face a growing tax squeeze as the Autumn Budget approaches, with changes due in 2027 set to bring most inherited pensions into the scope of inheritance tax.
From April 2027, most unspent pension pots left on death will count towards a person’s estate for inheritance tax, ending their status as a tax-efficient way to pass on wealth. At the same time, the long freeze in income tax thresholds means more retirees are likely to pay tax on their pension income as payments rise.
The government estimates the pension changes will drag an additional 10,500 estates into inheritance tax, while a further 38,500 could face larger bills, around 50,000 families in total.
For those affected, the average increase is expected to be about £34,000.
Angeline Ong, investing expert at IG, said the changes meant savers should review their retirement planning ahead of both Pensions Awareness Day and the Budget, as pensions are increasingly caught in the tax net.
She outlined several steps savers can take now to prepare, from reviewing how their pension would be treated on death to making the most of available allowances.
1. Get your pension paperwork in order before 2027
The new inheritance tax rules won’t just change how pensions are taxed when someone dies. They could make sorting out a pension more complicated for the family left behind.
HMRC’s latest guidance shows that where inheritance tax may be due, pension schemes could be instructed to withhold up to half of a beneficiary’s pension death benefits while the tax position is being resolved. Families will also need to bring together information about pensions and the wider estate to work out what is owed.
That makes good record-keeping more important. Know where your pensions are, make sure your family can find them and check that your beneficiary nominations still reflect your wishes. An expression-of-wish form completed 15 years ago may no longer reflect the family you have today.
2. Don’t assume an inherited pension escapes the new rules
The April 2027 deadline isn’t necessarily as simple as whether somebody dies before or after that date. HMRC’s latest technical note shows why families need to understand what happens to pensions as they pass between generations.
Someone could inherit pension money before the new rules take effect and leave some of it invested. If they then die after April 2027, those remaining inherited pension funds could form part of their own pension property for inheritance tax purposes.
If pensions form a significant part of your family’s wealth, don’t make assumptions based on how the system has worked in the past. Understand what you own, what you have inherited and how those assets could be treated under the new regime.
3. Work out what your pension will actually pay you
A pension statement with a big number at the bottom can create a false sense of security. What matters is what that pension will actually pay you after tax and inflation.
The Personal Allowance is set to remain at £12,570 and the higher-rate threshold at £50,270 until 2031. That means pension income can rise while the tax bands don’t move with it, potentially pulling more of your retirement income into tax over time.
Stress-test your projections now. Work out what you are on course to receive and what that could actually be worth in your pocket. Finding a shortfall at 40 gives you time to respond, whereas at 65 you may not get to do so.
4. Check what your pension is actually invested in
Your pension could eventually become one of the biggest assets you own, yet it’s also an investment many people rarely look under the bonnet of.
Diversification doesn’t simply mean owning lots of funds. You could have ten funds and still find that much of your retirement depends on the same companies, sectors or markets. Look underneath the labels and understand where your money is actually invested.
Risk should change with you too. A market fall at 35, when you have decades to recover, and a market fall just before you start drawing your pension are two very different things. As retirement gets closer, you need to think carefully about how much risk you can afford to take with money you may soon need to live on.
5. Couples need to stress-test what happens when one partner dies
Couples can make the mistake of looking at retirement as one household number. Underneath it are two State Pension records, potentially several workplace and private pensions, different retirement dates and different tax positions.
Map everything out individually first and then bring it together. Work out what each person receives, when they receive it and what happens if one retires several years before the other. Crucially, understand what happens to household income and pension wealth if one partner dies.
With the treatment of inherited pensions changing, that’s becoming even more important. A retirement plan isn’t complete because the numbers work when you’re both 67 and healthy. It should still make sense when life doesn’t follow the spreadsheet.