How to prevent 40% Inheritance Tax on your pension: 4 simple strategies

Since the introduction of pension freedoms in 2015, pensions have been a tax-efficient means of passing on wealth, as they are generally not within the scope of Inheritance Tax (IHT).

However, one of the key announcements in last year’s Autumn Budget was that pensions will be liable for IHT from April 2027, though the full details have yet to be finalised and remain under review.

The UK government estimates that this will lead to 10,500 estates becoming liable for IHT for the first time, and around 38,500 that will face a higher IHT bill than they would have before.

So, with around 50,000 estates likely to be affected by the changes coming in just over a year, now is a good time to make key interventions in your estate plan to prepare for the upcoming changes.

Read on to discover four simple strategies that can help ensure more of your unused pension is passed to your beneficiaries and the pros and cons of each.

1. Make full use of your nil-rate bands

For the 2025/26 tax year, the nil-rate band – the portion of your estate that isn’t subject to IHT – is set at £325,000.

On top of this, the residence nil-rate band offers an extra £175,000 allowance when you leave your main home to direct descendants such as children or grandchildren. However, this allowance tapers once your estate exceeds £2 million, reducing by £1 for every £2 over the threshold. You can read more about this in this article.

Together, the full residence nil-rate band and standard nil-rate band mean you can pass on up to £500,000 free from IHT.

Moreover, if you’re married or in a civil partnership, any unused allowances can be transferred to the surviving partner. That means, between you, it’s possible to leave as much as £1 million before IHT becomes payable.

Taking full advantage of these reliefs is one of the simplest and most effective ways to keep your estate’s IHT bill down. Since pensions are often one of the largest assets you’ll hold, these rules can be especially valuable in a marriage or civil partnership where one partner has a much larger pension than the other. In this instance, the partner with the bigger pension – who might otherwise exceed the IHT threshold – can benefit from inheriting a portion of their partner’s unused allowance.

To maximise your nil-rate bands, you may need to update your will to ensure your allowances are passed on correctly, or to make sure your property goes directly to the right heirs.

The only downside of this approach is that your beneficiaries will only receive the inheritance after both you and your spouse have died, rather than just one of you. However, the potential tax savings likely make this a worthwhile trade-off, and maximising your nil-rate bands is a highly valuable estate planning strategy.

2. Use more of your pension while you’re alive

One of the simplest ways to reduce the potential IHT liability on your pension is to use more of it while you’re alive.

With a well-structured withdrawal strategy, you can enjoy more of your savings in retirement and provide immediate support to your future beneficiaries, while simultaneously reducing the size of your pension pot that might eventually be subject to IHT.

You could also use the withdrawals to invest tax-efficiently on behalf of your loved ones, such as topping up a child or grandchild’s pension or Junior ISA, or even making charitable donations. You may also want to gift lump sums to your family.

However, it’s important to remember that gifts to individuals may still fall within the scope of IHT if you die within seven years, with tax charged at a tapered rate.

Furthermore, your withdrawals need to be tax-efficient and sustainable, so that you don’t risk undermining your long-term financial security.

A financial planner can help you put together a tailored plan that balances enjoying your wealth now with protecting your estate for the future.

3. Explore Business Relief schemes

Another option to consider is to use your pension to invest in a Business Relief (BR) scheme. If structured correctly, BR can provide up to 100% IHT relief, meaning those assets may be passed on free of tax.

You can claim 100% BR on:

• A business or interest in a business

• Shares in an unlisted company.

You can get 50% BR on:

• Shares controlling more than 50% of the voting rights in a listed company

• Land, buildings, or machinery owned by the deceased and used in a business they were a partner in or controlled

• Land, buildings, or machinery used in the business and held in a trust that it has the right to benefit from.

You can only get relief if you owned the business or asset for at least two years before you die.

Because BR investments are typically higher risk and the rules around them are complex, it’s important to speak to a financial planner before opting for this strategy. They can help you decide if it fits your circumstances and ensure any investments are structured appropriately.

4. Take out a life insurance policy and put it in trust

Taking out a life insurance policy and placing it in trust removes it from your estate, which means the payout goes directly to your beneficiaries. If you use your pension to cover the policy premiums, you’re effectively turning that money into an IHT-free benefit for your loved ones.

Whole-of-life assurance is usually the most effective option, as it guarantees a payout whenever you die, so long as you keep up the premiums. Term assurance, on the other hand, only covers you for a set period, so it may not always align with your estate planning needs.

That said, life insurance isn’t without its drawbacks. Premiums can be expensive, particularly for whole-of-life policies, and if you stop paying them, the cover ends, and you may get little or nothing back. The cost of premiums can also increase over time, depending on the policy type, and you’ll need to be comfortable committing part of your pension income to fund them.

Because of these trade-offs, it’s important to get advice. A financial planner can help you compare policy types, structure the trust correctly, and make sure the solution fits both your circumstances and your beneficiaries’ needs.

Get in touch

The upcoming pension and IHT reforms are likely to affect you, so it’s important to be prepared. A financial planner can help you explore a range of strategies that you can use to ensure more of your wealth is passed on to your loved ones once you're gone.

To speak to a financial planner, get in touch.

Email info@mlpwealth.co.uk or call us on 020 8296 1799.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.