Change could be on the horizon for pensions. On 21st July 2025, HMRC released a formal policy paper and draft legislation titled “Reforming Inheritance Tax — unused pension funds and death benefits” that will drag pension pots into the IHT net.
So, are pensions still the holy grail of tax efficiency in the future if the draft legislation is passed?
Why pensions are still tax-efficient
- Upfront Income Tax Relief
- Contributions still get relief at your marginal rate (20%, 40%, 45%).
- Employer contributions avoid both income tax and National Insurance.
- For higher-rate earners, that’s still the most generous relief in the system.
- Tax-free Growth
- Investments inside pensions grow free of CGT and income tax.
- With the Lifetime Allowance abolished, there’s no cap on growth.
- 25% Tax-free Lump Sum
- Still available when you start drawing benefits (subject to existing protections).
- Income Tax Management in Retirement
- Flexi-access drawdown allows you to phase withdrawals to stay in lower tax bands.
What changes from April 2027?
From April 2027, unused pension funds on death will generally be brought into the estate for IHT.
To this point, pensions have been a “double shelter” incurring no IHT, and income tax only when beneficiaries draw funds.
After April 2027, most pensions lose the IHT exemption (death-in-service benefits and some dependant annuities remain excluded). This means pensions shift from being a primary estate-planning vehicle to being primarily a personal tax-efficient retirement savings tool.
Practical Implications
Pensions are still tax-efficient for contributions and growth – nothing changes here. However, they are set to become less attractive as an inheritance vehicle – people who were overfunding pensions mainly to pass on wealth may need to rethink.
Another planning angle which could be considered is to spend pensions first in retirement and preserve ISAs/general investments to pass on, which can still benefit from the step-up in base cost and no IHT planning change.
We advise estate equalisation; families should review wills, nominations, and death-benefit structures before April 2027 to make sure they have the most efficient solution in please for them.
Pensions are still a great saving vehicle but for the wealthy, they are no longer guaranteed to be a tax-free inheritance wrapper after death
For more information, or to arrange a consultation, speak to our Senior Tax Consultant Nick Farmer on 01905 777600 or email nickfarmer@ormerodrutter.co.uk
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