Inheritance tax can take a 40% chunk out of your estate, but pensions could be your secret weapon to when it comes to passing on wealth.
Unlike most other assets, pensions usually fall outside of your estate for inheritance tax purposes. That makes them a powerful tool for long-term legacy planning, and one of the most tax-efficient ways to support your loved ones.
What is inheritance tax?
Inheritance tax (IHT) is a 40% tax applied to the portion of your estate that exceeds certain tax-free thresholds.
Currently, your estate includes everything you own at the time of your death, minus any debts or liabilities:
- Property or properties
- Cash savings and investments
- Possessions like cars, jewelry or art
- Non-discretionary pensions – the vast majority of pension schemes including SIPPS are discretionary and would not be included
What is the inheritance tax allowance?
- Nil-rate band (applies to all estates):
- Individuals: £325,000
- Couples: £650,000
- Residence nil-rate band (if you leave a property to a direct descendant):
- Individuals: £175,000
- Couples: £350,000
That brings it to a total threshold of £500,000 for individuals and £1,000,000 for couples. You only pay inheritance tax if the value of your estate exceeds these limits.
For example, if a couple leaves behind an estate worth £1.2 million, their tax-free threshold is £1 million, so the taxable portion is £200,000. Therefore, the inheritance tax would be 40% of £200,000 or £80,000.
Who has to pay inheritance tax?
The executor of your will handles the paperwork and pays any tax owed using your estate’s assets. From April 2027, any inheritance tax due from your pension will be managed by your pension scheme administrator.
And how do you choose who’s gonna handle your will? It should be a close relative or a friend whom you might trust with your life. No pun intended.
How do you use your pension to reduce inheritance tax?
Current rules
In April 2023, the UK government scrapped the pension lifetime allowance, which previously capped how much you could build up in pensions without facing heavy tax charges.
This means that there is no upper limit on the size of your pension pot. You can pass on large sums from your pension without triggering inheritance tax, as long as it’s still outside your estate.
What’s changing?
From April 2027, most defined contribution pensions—including SIPPs—will be included in your estate for IHT. So even though the lifetime cap is gone, inheritance tax may still apply if your estate exceeds the £325,000 (or £500,000 with property) threshold.
Anything left to your spouse or civil partner is normally automatically exempt from IHT, including your discretionary pension.
Why this matters?
Pensions currently remain one of the most tax-efficient ways to pass on wealth. That gives many people a window of opportunity to make use of pensions for legacy planning. Drawing income from other assets first and preserving your pension could help you reduce future IHT liabilities for your family.
What happens to your pension after you die?
If you die with unused pension savings, your provider will check who you’ve named as beneficiaries. These are the people you’ve asked to receive your pension.
If you haven’t made a nomination, the provider will decide—often choosing your next of kin, but this can cause delays or disputes. If you feel you need help, a qualified financial adviser can help you nominate pension shares to your beneficiaries.
If you die before 75, your beneficiaries can draw the money tax-free up to the lump sum death benefit allowance (LSDBA) of £1,073,100 – if transferred within 2 years.
If you die after 75, they’ll pay income tax on the amount of money withdrawn. Usually, 25% of the pension is free of income tax while 75% is taxable at your marginal tax rate.
After April 2027, these payments will be assessed after any inheritance tax liabilities have been accounted for.
How to protect your legacy?
With the new rules coming in 2027, smart estate planning is more important than ever. Here are some ways to take control:
- If you’re over 55, consider drawing down from your pension before it adds to your estate post-2027
- Make sure your will & nominations reflect your current wish
- Inheritance tax planning can be complex, so please speak to a financial advisor if you have any questions
How can InvestEngine help?
With an InvestEngine SIPP, you can grow your pension tax-efficiently and pass on more of your wealth:
- Low costs: No platform or dealing fees for DIY investors (ETF costs apply)
- Wide ETF choice: Invest in a range of major ETFs and other popular indices
- Automated investing: Use Savings Plans and AutoInvest to grow your pension without lifting a finger
Whether you’re investing for retirement or thinking about your legacy, we can help you take control of your financial future.
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.
Tax treatment depends on personal circumstances and is subject to change, and past performance is not a reliable indicator of future returns.