Pension Drawdown and IHT: Flexi-Access Drawdown, Uncrystallised Pensions, and the April 2027 Budget Change
Pension funds in flexi-access drawdown and uncrystallised pension funds are currently outside the estate — free from IHT. That changes from 6 April 2027, when unused pension death benefits will be inside the estate. There is a narrow window to restructure before the change takes effect.
Pension Drawdown and IHT: Current Rules and the 2027 Change
Current position: pension funds are outside the estate for IHT
Under the current rules (which apply until 5 April 2027), pension funds held in a defined contribution (DC) pension — including self-invested personal pensions (SIPPs), personal pensions, and workplace DC pensions — are outside the estate for IHT purposes. This applies to: (1) Uncrystallised pension funds: the full fund value before the pension holder has taken any benefits (no income drawdown taken, no tax-free cash taken); (2) Flexi-access drawdown funds (FAD): the remaining pension pot after the pension holder has designated funds into drawdown (taken the 25% tax-free cash lump sum, with the rest in drawdown); (3) Uncrystallised Funds Pension Lump Sum (UFPLS): where lump sums are taken directly from the uncrystallised fund, the remaining uncrystallised fund is outside the estate. The pension fund passes to the nominated beneficiary (or beneficiaries) through the pension provider's own discretionary process — it does not pass under the will, does not go through probate, and is not subject to IHT.
Death before 75 vs death after 75: income tax on inherited pension
Although the inherited pension fund is free from IHT, there is an income tax distinction between dying before and after age 75: (1) Death before age 75: the inherited pension fund can be paid to the nominated beneficiary as a lump sum or drawn down tax-free — no income tax on the amount received (subject to the lump sum and death benefit allowance, formerly the lifetime allowance). This is a particularly powerful IHT planning advantage: the pension fund passes completely tax-free both from IHT and income tax when the holder dies before 75. (2) Death after age 75: the inherited pension fund is still IHT-free (under current rules until April 2027) — but the nominated beneficiary pays income tax at their marginal rate as they draw funds from the inherited pension. The pension fund is not hit by income tax on the death itself; it arises only as the beneficiary withdraws. For a higher-rate taxpayer beneficiary, 40% income tax on withdrawals is still significantly better than IHT at 40% on the full fund with no income tax offset.
Nomination of beneficiary: critical for keeping pension outside estate
The IHT-free status of a pension on death depends critically on the fact that the pension is not legally owned by the deceased — it is held by the pension trustees, who have discretion over who receives the death benefits. The pension holder nominates beneficiaries through an expression of wishes (also called a beneficiary nomination form). The trustees consider this expression of wishes but are not legally bound by it — this is what keeps the pension outside the estate (it is the trustees' fund, not the deceased's). Consequences of the nomination: (1) A valid, up-to-date nomination ensures the pension reaches the intended beneficiaries quickly (often within weeks, without probate). (2) An outdated or missing nomination (e.g. still naming a deceased parent as beneficiary) can result in the pension being paid to the estate — bringing it into the estate for IHT and probate. (3) The nomination should be reviewed after every major life event: divorce, remarriage, death of a nominated beneficiary, birth of children or grandchildren. It should always be kept current and consistent with the will.
The April 2027 change: pension death benefits inside the IHT estate
The October 2024 Budget announced that unused pension funds and pension death benefits will be brought within the scope of IHT from 6 April 2027. The effect: from 6 April 2027, the pension fund value remaining on death will be included in the deceased's estate for IHT purposes. The full fund value (uncrystallised or flexi-access drawdown) will be aggregated with the rest of the estate and subject to IHT at 40% above the available NRB. The income tax position on drawdown by the beneficiary remains unchanged — the beneficiary still pays income tax on withdrawals at their marginal rate (or tax-free if the holder dies before 75, subject to the lump sum and death benefit allowance). The double charge that results (IHT on the fund value, then income tax on withdrawals by the beneficiary) is a significant change for those who hold large pension pots specifically for IHT planning. HMRC has confirmed that pension schemes will be responsible for calculating and paying the IHT due on pension death benefits, using information from the personal representative (executor) about the overall estate.
What to do before April 2027
Key strategies to consider before 6 April 2027: (1) Draw down and gift: if the pension pot is large, consider withdrawing cash from the pension (paying income tax on the withdrawal) and gifting the net cash as PETs. Each PET runs the 7-year clock. The total cash withdrawn net of income tax may be less than the 40% IHT on the full fund after April 2027 — especially for basic-rate taxpayers. (2) Pension contributions: reconsider making large new pension contributions if the primary motivation was IHT planning — after April 2027, new contributions to an oversized pension increase the IHT exposure rather than reducing it. (3) Review nomination: ensure the pension nomination is up to date and reflects the post-April 2027 IHT position. Where a surviving spouse is the nominated beneficiary, the spousal exemption may shield the pension fund on the first death — but the whole pension will then be in the surviving spouse's estate on the second death. (4) Consider drawdown: taking the 25% tax-free cash and drawing down the rest (paying income tax as you go) reduces the fund value in the pension — each withdrawal is outside the estate once it becomes cash in hand (or gifted). (5) Re-evaluate life insurance: a whole-of-life policy written in trust can fund the IHT on the pension fund at a predictable annual premium.
Frequently Asked Questions
Is my pension pot subject to inheritance tax when I die?
Under current rules (until 5 April 2027), no — pension funds in a defined contribution pension (SIPP, personal pension, workplace DC scheme) are outside your estate and not subject to IHT. Your pension passes to your nominated beneficiaries through the pension trustees' discretionary process — outside your will and outside the IHT calculation. From 6 April 2027, the October 2024 Budget changes this: your remaining pension fund will be included in your estate for IHT purposes from that date.
What is the difference between flexi-access drawdown and an uncrystallised pension fund for IHT?
Both are currently outside the IHT estate. An uncrystallised pension fund is where you have not yet taken any benefits from your pension. Flexi-access drawdown is where you have designated funds to drawdown — typically taken the 25% tax-free cash and moved the rest into a drawdown account. The IHT treatment is the same: both are outside your estate on death under current rules. From April 2027, both will be inside your estate.
If my pension passes to my spouse, is there IHT?
Under current rules, no — the pension is outside the estate entirely, so the spousal exemption is not needed. Under the April 2027 change, the pension will be inside the estate, but the spousal exemption will apply if it passes to a spouse or civil partner — so no IHT on the first death where the surviving spouse is the nominated beneficiary. However, the pension will then be in the surviving spouse's estate on the second death, potentially creating a larger combined IHT charge. Review whether directing the pension to children directly (bypassing the surviving spouse) produces a better overall IHT outcome — this is highly individual and depends on estate values, available NRB, and family circumstances.
Should I take my pension early to reduce IHT?
Not necessarily — taking the pension early means paying income tax on the withdrawn amount (at 20%, 40%, or 45% depending on your income). If you are in good health and expect to live more than 7 years, drawing down and gifting the cash as PETs might be tax-efficient. But if the primary pension purpose is retirement income rather than IHT planning, withdrawing early and paying income tax may cost more overall than the IHT saving. The calculation depends on: your marginal income tax rate, the size of your pension fund, how many years you are likely to live, and what alternative IHT planning is available. Specialist financial and tax advice is essential before making pension drawdown decisions for IHT purposes.
What happens to my pension nomination after April 2027?
Your nomination of beneficiaries remains critically important after April 2027. The mechanics change: the pension trustees will need to calculate the IHT on the pension fund as part of the estate (working with your executor), but the pension will still pass to your nominated beneficiaries (net of IHT). The spousal exemption will apply to the pension passing to a surviving spouse — so the nomination of your spouse as beneficiary on first death remains IHT-free. Keep your nomination current and consistent with your will — and review it in light of the April 2027 change.
Keep Your Pension Nomination and Will Aligned
Your pension nomination and your will must work together — especially after April 2027 when the pension becomes part of the IHT estate. A WillSafe will kit helps you structure what passes through your will, while your pension provider handles the nomination that directs the pension fund.
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