Pensions, Inheritance Tax and the 2027 Change: Why Giving It Away Can Backfire
From April 2027, unused pension funds are expected to fall within inheritance tax. Before you draw down and start gifting, understand the double-tax trap, the deprivation of assets risk, and what the change means for internationally mobile families.
The reform of how pensions are taxed on death is prompting a good deal of hurried decision-making. From 6 April 2027, unused money-purchase (defined contribution) pension funds are expected to be brought within the estate for inheritance tax. For anyone who had treated their pension as a tax-efficient way to pass on wealth, that is a significant change, and the instinctive response, to take money out and give it away, is understandable. It is also where a good many people are about to make expensive mistakes.
This note sets out what is changing, why the obvious reaction carries risks that are easy to overlook, and why a pension decision taken in isolation from the rest of your position, particularly for those with connections to more than one country, is rarely a decision taken well.
What is actually changing
Under the current rules, an unused pension fund generally sits outside your estate for inheritance tax, which is what has made it such an effective vehicle for passing wealth down a generation. From April 2027 that advantage is expected to fall away, and the fund will be counted alongside your other assets when the inheritance tax on your estate is worked out, with tax charged at 40% above your available allowances.
There is a second charge that is less well understood. Where you die at or after the age of 75, the beneficiary who inherits your pension already pays income tax, at their own marginal rate, on what they draw from it. That charge does not disappear in 2027. So the same pension fund can be exposed both to inheritance tax on your death and to income tax in your beneficiary's hands, a combination that, for a higher-rate beneficiary, removes a substantial part of the fund.
It is the prospect of that double charge, rather than the headline inheritance tax rate alone, that is driving people to act.
The instinct to draw down and give it away
The common reaction is to take the tax-free lump sum, draw more heavily on the pension, and gift the proceeds to children or grandchildren, or to spend it, so that there is no surplus fund left to be taxed on death. In principle, lifetime giving is a legitimate and well-established part of inheritance tax planning. Most gifts fall out of your estate entirely if you survive them by seven years, and there are valuable exemptions, including an annual allowance and, importantly for pensioners, the exemption for gifts made out of surplus income.
The difficulty is that a large withdrawal followed by a large gift solves one problem while quietly creating others. The withdrawal itself may be taxable income in the year you take it, potentially at higher rates. The gift only leaves your estate if you live long enough. And, as the next section explains, giving money away shortly before it might have been needed can rebound in a way that has nothing to do with the tax system at all.
| Common reaction | The intended benefit | The question to weigh first |
|---|---|---|
| Draw down and gift cash | Removes the fund from a future IHT charge | Is the withdrawal itself taxable now, and will you survive the gift by seven years? |
| Spend down the pension | Nothing left to tax on death | Will enough remain to fund your own later-life needs, including care? |
| Transfer property to children | Reduces the taxable estate | Have you kept a benefit (a gift with reservation), and how will a care assessment view it? |
| Move assets into trust | Control and succession planning | Trusts have their own tax regime and are closely examined in care assessments |
None of these is wrong in the right circumstances. Each is capable of going wrong when done in haste and in isolation.
The deprivation of assets trap
This is the risk that the tax commentary most often omits, and the one most likely to affect ordinary families. If you later need residential or nursing care and ask your local authority to help with the cost, the council carries out a financial assessment. If it concludes that you deliberately reduced your assets in order to avoid paying for care, it can treat you as though you still hold the money you gave away. This is the concept of notional capital, and the consequences are practical: you may be assessed to pay as if the gift had never happened, and in some cases the authority will look to recover funds from the family members who received it.
Two points make this a serious trap for the unwary. First, unlike the seven-year rule for inheritance tax, there is no fixed time limit on how far back an authority can look. A gift is not "safe" simply because a number of years have passed. Second, what matters is whether a need for care was reasonably foreseeable at the time of the gift. A transfer made in good health, years before any decline, is far easier to justify than one made after a diagnosis or a noticeable loss of independence. Residential care is expensive, in some areas well beyond £1,500 a week, so the sums at stake are not trivial.
There is a further trap where someone acts under a Lasting Power of Attorney. An attorney is legally bound to act in the donor's best interests and to protect their future security, not to reduce a future inheritance tax bill. Large gifts made by an attorney without proper authority can be challenged by the Office of the Public Guardian or the Court of Protection, quite apart from any care assessment. Encouraging an attorney to give away an elderly relative's pension savings is rarely the straightforward step it appears.
Know what you hold before you touch it
Much of the anxiety around the 2027 change comes from a simple absence of a clear picture. Many people hold several pensions accumulated across a working life, some in modern schemes and some in older ones, and cannot readily say what they are worth or what death benefits they carry. You cannot plan sensibly around a figure you have not established.
Bringing that picture together is worthwhile in its own right. It is worth saying clearly, though, that transferring or consolidating pensions is regulated financial advice, which we do not provide, and that some older schemes carry guarantees, such as guaranteed annuity rates, protected tax-free cash or valuable spousal benefits, that should not be given up without regulated advice. Defined benefit (final salary) pensions worth more than £30,000 cannot, in any event, be transferred without it. Our role is the tax analysis that sits alongside those decisions, and the coordination between it and the advice of your financial adviser.
The cross-border dimension
For internationally mobile families, the 2027 change lands on top of a system that was itself reshaped in 2025. From 6 April 2025, inheritance tax moved from a domicile basis to a residence basis: broadly, once you have been UK resident for 10 of the last 20 years you become a long-term resident and your worldwide estate can fall within the UK charge. A UK pension is a UK asset, and the interaction between the 2027 pension change, your residence position, and the place your beneficiaries live is exactly the kind of question that a purely domestic view will miss.
Several points deserve care. Where a beneficiary is resident overseas, the income tax treatment of an inherited pension may differ, and a double tax agreement may be in point. Very few countries have an estate or inheritance tax treaty with the UK, so relief from double charges is not something to assume. And the deprivation of assets rules are a feature of the UK social-care system: they matter most where a client, or a parent, may return to the UK for care in later life. Planning that works cleanly for a UK-only family can behave quite differently once a second country is involved.
What to keep on file
If you do make substantial gifts, the evidence you keep now is what protects your family later. Contemporaneous notes of why a gift was made, records of your financial position and cashflow showing that you retained enough to meet your own needs, evidence of your health at the time, and any pattern of regular giving all help to demonstrate that the purpose was genuine estate planning or family support rather than the avoidance of care fees. Without that record, defending the position years later becomes considerably harder.
How we can help
A pension decision taken in the round is usually a manageable one. Taken in isolation, in response to a headline, it is where the costs arise. We advise on the inheritance tax position of your estate, including your pensions, the use of the available exemptions, and the residence questions that determine how much of your worldwide wealth is in scope. For internationally connected clients we consider what your position means across borders, and we work alongside your financial adviser and, where care or capacity is in point, your solicitor, so that the tax planning and the wider picture pull in the same direction.
At Expat UK Tax we specialise in UK tax for individuals and families who live, work and invest across borders. If the 2027 pension change affects you, or a member of your family, please get in touch before acting, and we will help you weigh it properly.
