When Rachel Reeves announced that unused pension funds would come under the scope of inheritance tax from 6 April 2027, she changed retirement planning for thousands nationwide.
For decades, pensions have been the gold standard for estate planning. Business owners could build substantial pension pots, knowing that any unused funds would pass to beneficiaries free from inheritance tax. That safety net disappears in two years’ time.
What exactly changes in 2027?
From 6 April 2027, any unused pension funds will be subject to inheritance tax at a rate of 40%. Previously, these funds sat outside your estate entirely.
This applies to:
- Defined contribution pensions (personal pensions, SIPPs, workplace money purchase schemes)
- Defined benefit pensions (final salary schemes)
- Both crystallised and uncrystallised pension funds
- Death benefits from registered pension schemes
Take someone who has built up a £600,000 pension pot and has other assets worth £400,000. Under current rules, only the £400,000 estate is subject to inheritance tax. With the residence nil-rate band and standard allowances, beneficiaries would likely pay no inheritance tax at all.
After April 2027, her entire estate will be worth £1 million. Her estate is not subject to IHT where it was not before, and her beneficiaries will face a tax bill.
As we can see, the pension update applies to both defined contribution and defined benefit schemes. It doesn’t matter whether you’ve been drawing from your pension or leaving it untouched. If there’s money left upon death, it will count towards IHT.
The double tax trap
If someone dies after age 75, the beneficiaries could face both inheritance tax and income tax on the same pension funds. Under current rules, beneficiaries can withdraw pension death benefits tax-free if you die before 75, but they pay income tax at their marginal rate if you die after 75.
From 2027, the inheritance tax will be applied at a rate of 40%. Then, when beneficiaries withdraw money from the inherited pension, they pay income tax at their marginal rate on top of that.
A higher-rate taxpaying beneficiary could see over 60% of a pension payment disappear in taxes.
Why this hits business owners particularly hard
Business owners face a unique challenge here. Many have built substantial pension pots precisely because they couldn’t rely on employer contributions or final salary schemes. The self-employed and company directors have used pensions as their primary retirement vehicle and estate planning tool.
The more successful you’ve been at building your pension, the bigger the tax hit your family faces. A £1 million pension pot that was previously inheritance tax-free now generates a £400,000 bill for your beneficiaries.
Many have been advised to draw from other assets first, thereby preserving their pension for inheritance tax planning purposes. That route is set to change.
What you can do now
The good news is that you have two years to plan. The key is to start thinking about your pension in a different way. Instead of seeing it as an inheritance tax shelter, treat it as what it was originally designed to be: retirement income.
Here’s what business owners should be doing right now:
- Review your withdrawal pattern: If you’re already retired, consider drawing more from your pension and less from other assets
- Reassess your contribution levels: Focus on what you’ll actually need in retirement rather than maximising pension savings
- Update your estate planning: Factor pension values into your overall inheritance tax calculations
- Consider lifetime gifts: Use the money you would have put into pensions for potentially exempt transfers instead
- Plan your drawdown timeline: Start thinking about when and how you’ll access your pension to minimise the inheritance tax impact
Start now and you’ll have a strong chance of rebalancing your pension strategies to avoid the worst of the changes.
Making the most of remaining time
The next two years prior to the pension update offer valuable planning opportunities. Company directors have particular flexibility here, as earnings do not restrict employer contributions in the same way that personal contributions do.
While personal contributions are limited to 100% of your earnings (or £3,600 if higher), employer contributions from your company can use the full £60,000 annual allowance regardless of your salary level.
This means you could have a modest salary of £12,570 but still make a £60,000 employer pension contribution, provided your company has sufficient profits and the contribution meets HMRC’s “wholly and exclusively for business purposes” test.
For many business owners, a balanced method makes more sense. Fund what you’ll actually need for retirement, use other tax-efficient vehicles like ISAs or VCTs, and plan your drawdown to minimise inheritance tax impact.
Getting professional help
These changes are complex, and the interactions between pension rules, inheritance tax, and business taxation create numerous points of contention.
The calculations involved in working out optimal methods can be complicated, particularly when you factor in things like the tapered annual allowance for high earners or the money purchase annual allowance if you’ve already accessed benefits.
Business owners who face particular challenges include:
- Those with large pension pots who haven’t started drawing benefits
- Company directors who’ve been maximising employer contributions for inheritance tax planning
- Business owners planning to sell within the next few years
- Anyone whose total estate (including pensions) will exceed £1 million after 2027
Obtaining robust advice now, while you still have time to plan, could save your family tens of thousands in unnecessary tax.
The bottom line
The 2027 pension update represents the biggest alteration in retirement planning for a generation. For business owners who’ve built substantial pension wealth, they require fundamental rethinking of financial methods.
But they’re not the end of the world. Pensions remain excellent vehicles for retirement savings. They just need to be used more tactically, with a clear focus on funding your actual retirement rather than minimising inheritance tax.
The key is to start planning now. Two years might seem like plenty of time, but good financial planning takes time to implement properly. The business owners who start adapting their methods now will be the ones who minimise the impact on their families.
At Thomas Barrie & Co., we’ve been helping business owners adapt to these changes since they were announced. Our experienced team can help you model various scenarios, understand how the new rules impact your specific situation, and develop methods that work for both your business and your family. Contact us today to discuss how we can help you maximise the time remaining before these important changes take effect.