One year until inheritance tax applies to pensions – how to prepare

With only 12 months until pensions are brought into the scope of inheritance tax, many people are reviewing their estate planning.

In our recent survey of Which? members, a quarter said the new rules will alter their estate planning, while two in five expressed concern about the changes – even if they were unsure exactly how their finances would be affected.

Here we explain how the changes could affect you, how others are currently preparing, and what you can do to minimise a potential inheritance tax bill.

• Select Which? as a preferred source on Google so you can see more independent news written by expert Which? journalists. 

How are inheritance tax rules changing?

Inheritance tax is charged on the value of an estate (this includes property, savings, possessions and investments) that exceeds your tax-free thresholds.

Thanks to the nil-rate band, everyone can pass on £325,000 tax-free – with an additional allowance of up to £175,000 if you’re leaving your estate to direct descendants.

As a result, only a small proportion of deaths each year (around 4%) result in an inheritance tax bill.  

However, that number is set to rise from April 2027, when pension savings are included as part of an individual’s taxable estate. Previously, any unspent pensions could be passed on tax-free. 

Government estimates suggest that the changes will result in 10,500 estates paying inheritance tax for the first time in 2027-28, while 38,500 more will see their bills increase (by around £34,000 on average).

What can you do to prepare?

Inheritance tax can be legally mitigated, provided you understand the complex rules. We asked Which? members how they’re preparing for next year’s changes – here are the key strategies they are using.

Spend more during retirement

Before the changes were announced, pensions had been seen as a tax-efficient way to pass on wealth. But the new rules have prompted people to take more out of their pot than they otherwise would have done. 

Our survey shows that one in seven people are already spending more of their pension in anticipation of the changes. And almost half of respondents say they plan to do the same. 

Meanwhile, the number of people taking their tax-free pension lump sums at the earliest opportunity has reached a five-year high: some 116,000 people aged 55 withdrew pension lump sums in 2024-25, worth a total of £2.3bn.

How to do it

This strategy involves striking a balance between enjoying your money now, and leaving enough to cover expenses you might face in future, such as care costs. 

• Find out more: 7 things to know about inheritance tax changes and your pension

What to be aware of

• Outliving savings: spending more now could help you minimise a potential tax bill later on, but it may leave you without a financial buffer for later-life essentials, such as private medical treatment or care home costs.
  
• Tax efficiency: while you can take 25% of your pension tax-free, the remaining 75% is taxed at your marginal rate. Withdrawing a large sum in one go could inadvertently push you into a higher tax bracket, potentially costing you more in the short term.
• 60% tax trap: if your total annual income reaches £100,000, you begin to lose your personal allowance. This creates an effective tax rate of 60% on income between £100,000 and £125,140.

Gift more to loved ones

Giving money away during your lifetime is a simple way to reduce the value of your estate – and potentially avoid an inheritance tax bill altogether.

One in five respondents to our survey said they’ve already increased the amount they’ve given to loved ones over their lifetimes, and two in five are considering doing so in the future.

How to do it

Gifts made using the following allowances will never be subject to tax:

• Main allowance: you can give away £3,000 tax-free each tax year. 
• Small gifts: you can give up to £250 to as many people as you like.
• Weddings: you can give £5,000 to children, £2,500 to grandchildren, or £1,000 to others.

Another option is to make gifts out of surplus income. You can give away any amount of money tax-free as long as it’s paid on a regular basis and does not diminish your standard of living. 

If you’re doing this, then you must also keep detailed records of your income and gifts to prove to HMRC that these payments were truly from surplus income.

• Find out more: inheritance tax planning and tax-free gifts

What to be aware of

• The seven-year rule: if you make gifts that fall outside of your tax-free allowances, you must live for at least seven years after making the gift for it to fall outside of your estate for inheritance tax purposes. If you die within this window, the gift will count towards the value of your estate.
• Depleting your allowance: if you die within those seven years, these gifts use up your £325,000 nil-rate band first. This can leave your home or other savings exposed to a 40% tax bill.
• Gifts with reservation: you cannot gift an asset but still benefit from it. For example, if you gift your home to your children but continue to live there rent-free, HMRC will still treat it as part of your estate.
• Immediate tax triggers: gifting certain assets, such as shares or a second home, can trigger an immediate capital gains tax bill at the time of the gift.
• Permanence: gifts are legally permanent. You cannot reclaim the money once it is gone, so you must ensure you have retained enough to cover future needs, such as long-term care.

Donate to charity 

Leaving gifts to charity in your will can not only support good causes but also reduce an inheritance tax bill.

Any money you leave to charity is tax-free and reduces the total value of your estate. If you give away at least 10% of your estate, the tax rate on the rest of your assets drops from 40% to 36%.

Our research shows one in 10 have already given more to charity, and one in six are planning to leave more of their pension to a charitable cause in their will.

How to do it

There are different ways you can leave a gift to charity in your will. This includes leaving a fixed sum of money, a specific asset (such as a property) or a percentage of your estate.

To reduce your tax liability, you’ll need to leave at least 10% of your overall baseline estate. The baseline of your estate is the value after the nil rate band and any other reliefs and exemptions have been applied.

• Find out more: the tax advantages of leaving money to charity in your will

What to be aware of 

• The charity’s status: for your gift to qualify for a lower inheritance tax liability, the charity needs to be officially registered with the Charity Commission and recognised by HMRC. While most UK charities are, some smaller or international groups may not be. 
• How your pension will be passed on: don’t assume your pension will be covered by your will. Make sure you complete a ‘nomination form’ or an expression of wishes with your pension provider to ensure the funds are directed to your chosen charity.

Buy an annuity

Annuities are growing in popularity thanks to improved rates. Purchasing an annuity reduces your estate immediately because the money you exchange for it is removed from your taxable assets. 

Our research found that 6% have already bought an annuity in response to the upcoming inheritance tax changes, while one in eight are planning to do so.

How to do it

An annuity involves swapping some or all of your pension pot for a regular, guaranteed income for the rest of your life or for a fixed term. 

Annuities come in several forms, including level options that pay a fixed amount and escalating annuities where payments rise over time. You can opt for a single-life product, where payouts stop when you die, or a joint-life annuity, where payments continue to be made after your death (usually to a spouse or civil partner). These payouts will continue to be exempt from inheritance tax.

You should always shop around to find the best annuity rate.

What to be aware of 

• What happens to payments when you die: not all annuities continue to pay out once you’ve died – if this is important to you, make sure you choose the right type.
• Inflation risk: a fixed income will lose its purchasing power over time. You can avoid this by opting for an escalating annuity, but payments are much lower to begin with. 
• Lack of flexibility: an annuity is a permanent contract. Once the initial cooling-off period ends, you can’t cancel or change the agreement.

Put a life insurance policy in trust

Life insurance sales have surged in the past year as more people look for ways to mitigate the impact of inheritance tax in view of the upcoming rule changes. 

Our survey found that 4% have opted for a life insurance policy to help with a potential inheritance tax bill, with one in eight planning to do so. 

How to do it

If your life insurance policy is written in trust, the payout is usually exempt from inheritance tax, meaning it can help beneficiaries settle the bill without having to sell assets.

A ‘whole of life’ policy will pay out when you die – regardless of when that happens, while term insurance pays out if you die during the term of the policy.

You can choose whoever you like as your beneficiaries, often it’s family members or friends – although you can also choose to leave this money to charity too. 

How much cover you will need depends on what you want your beneficiaries to do with the payout. If you’re using life insurance to cover some or all of an inheritance tax bill, you need to find out how much this is likely to be. 

If the payout is specifically for inheritance tax, you must also let your executors know so they can use the proceeds to settle a bill with HMRC.

• Find out more: how to write life insurance in trust 

What to be aware of

• Costs: life insurance can be expensive, as premiums often increase significantly with age or health complications.
• Inflexibility: missing payments may cause the policy to lapse, depending on the type of cover you have.
• The importance of a trust: if a policy is not written in trust, the payout is added to your estate and is taxable.
• Difficult to change: once a policy is placed in a trust, it can be hard to adjust the beneficiaries or terms if your family circumstances change.