Inheritance tax beginning to apply to unspent pensions in the UK from April 2027 represents a “massive change” for estate planning, a financial adviser has said.

Sean McCann from NFU Mutual said it has been common practice for farmers to pay into a pension with the intention of leaving the fund to non-farming children free of inheritance tax.

While new inheritance tax rules for pensions were announced in the Autumn Budget back in October 2024, they have been mostly overshadowed by changes to Agricultural Property Relief (APR).

Speaking to the Irish Farmers Journal, McCann pointed out that the new rules on pensions will not kick in for 12 months after the controversial changes to APR come into effect in April 2026.

“Don’t do anything with unspent pension funds at the moment because it still has protection from inheritance tax for another two years.

“If someone takes all their money out of a pension, puts it in the bank, and dies before April 2027, it will be subject to 40% inheritance tax,” he said.

Tax planning

However, tax planning for unspent pensions will be strongly recommended as April 2027 draws closer because inheritance tax and income tax can quickly eat into a fund.

McCann gives the example of a pension fund worth £100,000 which has the full 40% rate of inheritance tax applied, taking it to £60,000.

If the pension holder dies after they turn 75 years old, then their family needs to pay income tax when the fund is drawn down.

If the money is taken out in one lump, then the 40% higher rate of income tax will apply in most cases, which could take up to £24,000 off the pension fund.

“That would take the original £100,000 down to £36,000, so it is a big problem. Most families would probably opt to take it out in numerous payments over time, hopefully when they are not higher rate income taxpayers,” McCann said.

Lump sum and gifts

After April 2027, as pension holders approach their 75th birthday many are likely to be advised to avail of the tax-free lump sum, which usually allows up to 25% of a pension to be drawn down without paying tax.

“If you take that and put it in the bank, the worst that can happen is that it will be subject to inheritance tax, but not income tax as well,” McCann said.

Another option is to start taking money out of your pension and give it away to family during your lifetime.

“There is an exemption called ‘gifts out of normal expenditure’ which means you can give away any amount free of inheritance tax provided it is coming from your income, so not out of capital,” McCann explained.

He said this exemption also requires gifts to be made regularly, for example every year or six months, and it must not impact on the pension holder’s normal standard of living.

“We think we will see more older people tapping into their pensions and immediately giving it away,” he said.