Pensions and IHT: Advance Tax, Not a Double Whammy

It’s not often we say this, but the latest inheritance tax (IHT) reforms on pensions may be less damaging than they sound — at least, when someone dies aged over 75.

After a period of silence, HMRC has now confirmed how the new rules will work. And while there’s a headline IHT charge on unused pension funds from April 2027, there’s also a powerful offset mechanism that keeps things fair — if you know how to use it.

Let’s unpack the details — and explore some smart planning angles too.

The Rule Change: From April 2027

If you die after 75 with pension funds left over, those funds may now form part of your taxable estate for IHT purposes — typically taxed at 40%.

This is a big shift. Pensions have long been outside the IHT net, making them an incredibly efficient way to pass on wealth.

But here’s the nuance: HMRC won’t tax the same money twice.

Income Tax Relief: But Only on the IHT Charged to the Pension Fund

If your pension fund is hit with IHT when you die, and your beneficiaries later pay income tax on withdrawals from that fund, they can reclaim the income tax — up to the amount of IHT actually charged against the pension.

That last part is crucial.

Let’s say:

• Your total estate pays £400,000 in IHT.
• But only £200,000 of that was attributable to your pension fund.
• Your beneficiaries can reclaim income tax only up to £200,000, not the full £400,000 — because the reclaim is tied only to the pension portion.

So it’s a reclaim mechanism — but not a blanket one.

How It Works in Practice

Assume:

• A £2m estate: £1m in cash, £1m in pension.
• £400k total IHT bill, with £200k applying to the pension.
• IHT is paid from cash.

Now, a beneficiary draws £50k/year from the inherited pension:

• If they pay 40% income tax, they pay £20k/year and can reclaim that amount — reclaiming the full £200k over 10 years.
• If they’re a basic-rate taxpayer, they reclaim £10k/year — taking 20 years to fully recoup the IHT.

The good news? No tax is paid twice. It’s just a matter of time.

What About Deaths Before Age 75?

That’s where the sting lies.

Pension death benefits remain income-tax free if paid within two years — but under the new rules, they may still be subject to IHT.

And because the beneficiary isn’t paying income tax, there’s no reclaim mechanism. In this case, the 40% IHT is permanent.

New Planning Opportunities to Explore

Here’s where things get interesting. These reforms actually open up planning strategies for clients willing to think ahead:

1.   Deliberately Maximise the Pension IHT Share

If IHT can only be reclaimed via income tax on pensions — then it makes sense to:

• Gift away other assets (e.g. cash) during your lifetime to reduce their IHT exposure.
• This pushes more of the estate value into the pension, where any IHT can later be reclaimed — unlike with cash, property, or ISAs.

Done correctly, this creates a reclaimable tax event, rather than a final charge.

2. Optimise Pension Contributions

Even for older or higher-earning clients, making the most of carry forward and annual allowance adds more value into a tax-efficient, reclaimable environment.

Why invest into assets that will be taxed twice (like buy-to-let property), when pensions:

• Attract tax relief on the way in,
• Grow free of CGT and income tax,
• And now, even if hit by IHT, give the family a way to reclaim it?

It strengthens the already-compelling case for boosting pension funding.

3. Property vs. Pension: A Strategic Shift

Property wealth often gets hit on both sides:

• 40% IHT on death, and
• Ongoing income tax on rental profits for beneficiaries.

That tax burden is not reclaimable.

By contrast, pensions offer:

• Full tax shelter during life,
• Tax-deferred income in retirement,
• And now a route to recover IHT — if structured and drawn correctly.

So, if you're still holding investment property as a long-term inheritance tool, it may be time to rethink. Pensions now win on all fronts — especially from an intergenerational perspective.

Summary Table

Final Thoughts

On the surface, these IHT reforms sound like a tax raid on pensions. But with the right strategy, they actually offer more control, not less.

For clients over 75, pension IHT now acts more like a prepayment — reclaimable over time. For clients under 75, the stakes are higher — so planning becomes even more important.

Either way, pensions remain a core tool for intelligent, tax-efficient estate planning. And with changes like this, the conversation around "property vs pension" is tilting further in pensions’ favour.

By Daren Wallbank | Chartered Financial Planner

Inheritance Tax/Estate Planning is not regulated by the Financial Conduct Authority.

Approver Quilter Financial Services Limited Ltd 16/09/25