9 ways to protect your pension from IHT changes

From 6 April 2027, most pensions will be included in your estate for inheritance tax (IHT) purposes. For many people, this marks a major shift in retirement and estate planning. Pensions have long been one of the most tax-efficient ways to pass on wealth, but that advantage is now being significantly eroded - and in some cases, removed altogether.

So, what should you be doing now to limit the impact? Below are nine key things to consider.

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1. Rethink the “ISA first then pension” strategy

The previous rule of thumb for many retirees was to use up their ISAs and other assets first, leaving their pension untouched for as long as possible. This wasn’t true in all cases and the strategy hinged on the fact that pensions typically fell outside the IHT net. From 2027, that logic may no longer hold for many people.

For some, it may now be more efficient to use pension savings during your lifetime rather than leaving them exposed to IHT - particularly given the potential for “double taxation” outlined below.

2. Plan around the risk of “double taxation”

One of the biggest changes is the potential for pensions to be taxed twice on death, with:

• Inheritance tax (of 40%) potentially due on the value of the pension
• Income tax (at the beneficiary’s marginal rate) may be due when they withdraw funds - although this only applies if the pension holder dies after age 75

If both taxes apply, this could result in effective tax rates of more than 60%.

This is why some people may now prefer to spend their pension before other assets to avoid this double taxation. Those who do not need the money may look to withdraw money from their pension and gift the proceeds during their lifetime.

• Read: 5 IHT mistakes that could cost you thousands

3. Take your tax-free cash at the right time

When you die, the opportunity to take tax-free cash from your pension disappears with you.

Therefore, if you’re approaching age 75 and haven’t taken your tax-free cash, it may be worth reviewing your position.

Taking this cash earlier could:

• Reduce the value of your pension subject to IHT
• Allow you to reinvest or gift the funds more efficiently

If you don’t spend or gift the money (using one of the IHT gifting allowances), then it won’t reduce your overall IHT liability however it could help to avoid the double taxation outlined above. If you have unused ISA allowance and want to keep the tax-free cash invested, then an ISA could be a good home for it.

• Read: 8 questions before you take tax-free cash from your pension

4. Increase your focus on lifetime gifting

If your estate is likely to get caught in the scope of IHT and you know you have more money than you need, gifting is a helpful option.

HMRC has various gifting allowances which enable you to give away money during your lifetime, without incurring IHT, including:

• Up to £3,000 per tax year using the annual gift allowance
• Up to £5,000 per child for a wedding (the amount is less for grandchildren or other people)
• A potentially unlimited amount provided that the gifts are made regularly from surplus income, and you can afford the payments after meeting your usual living costs. This is known as the allowance for ‘normal expenditure out of income’.
• Up to £250 per person to as many people as you like each tax year using the small gift allowance. The small gift allowance cannot be combined with any other allowance.

Outside of the gifts shown above, (which are immediately exempt), larger gifts generally require the person making the gift to survive for seven years after making it to be exempt from IHT.

• Watch: Inheritance tax - What people get wrong about the 7-year rule

5. Consider using annuities strategically

The new IHT rules could make annuities (long unpopular among retirees) a more attractive option.

Annuities provide a secure income stream, and any surplus income could then be gifted to your loved ones using the ‘normal expenditure out of income’ allowance.

You can still use this allowance if you are taking your pension income via drawdown - but HMRC requires detailed record-keeping to prove the money being gifted is from a regular income and is not required to maintain your lifestyle. An annuity could make keeping records on regular income easier.

6. Review your beneficiary nominations and control structures

With changes afoot, who receives your pension (and how) matters more than ever.

Make sure to review:

• The people you have nominated to receive your pension on your death (via your Expression of Wish forms)
• Whether you want to set up a trust to control not just who gets the money, but how and when they get it.

Remember that trusts come with a complex set of tax implications, so they typically only make sense for larger or more complex estates.

• Read: 5 common IHT scenarios - from best to worst

7. Consider insurance to cover the tax bill

New rules will mean that some families face larger IHT bills, so you may need to plan for how that tax is paid. One option is to take out a whole-of-life insurance policy written in trust.

This can:

• Provide a lump sum on death
• Help beneficiaries pay the IHT bill without needing to sell assets 

This can be particularly useful where estates include illiquid assets, such as property or a family business. It’s a good idea to speak to a qualified financial adviser to understand the best options for your specific situation and to ensure the policy is structured appropriately.

8. Revisit how your assets are structured

The changes mean it’s no longer just about how much you have, but where it’s held.

For example, previously pensions were ideal for long-term growth and passing on wealth, so advisers often put higher-growth assets in pensions
However, if you are now planning to use your pension money first, it may make more sense to place income-paying investments in the pension and higher-growth assets into ISAs - although this will depend on your individual circumstances and should be reviewed regularly.

• Watch: Why are retirees rushing back to this income option?

9. Don’t overlook charitable giving

Charitable donations are IHT-free and can reduce the taxable value of your estate. What’s more, if you leave at least 10% of the "baseline amount" of your estate to charity, then the IHT rate on the rest of your taxable estate drops from 40% to 36%.

The baseline amount is calculated after deducting debts, liabilities, exemptions, reliefs and the nil-rate band, but ignoring the residence nil-rate band and before deducting the charitable gift itself.

For those already considering philanthropic gifts, this can be a tax-efficient way to reduce the impact of the new rules. The organisation must be a registered UK charity to qualify for IHT relief. 

What should you do next?

The right approach will depend on your individual circumstances - but in most cases, it’s worth reviewing:

• How and when you plan to draw from your pension
• Your exposure to IHT across your whole estate
• Opportunities to gift during your lifetime
• Whether your nominations and plans are still fit for purpose
• Whether you would benefit from speaking to a financial adviser (for people with large potential IHT liabilities or complex circumstances, this could be particularly valuable)

With the changes coming in 2027, there is still time to act, but early planning will make a significant difference.

Please remember that none of this is financial advice.

The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

Got a burning question you want to ask? Why not drop us a line. Click here to ask your question.

• Read: This IHT mistake could cost you £78,000
• Read: IHT problem? Try combining these perks
• Read: What is inheritance tax? The basics

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). Tax treatment depends on individual circumstances and all tax rules may change in the future. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.