Pension changes 2027: Double taxation?

In 2024, then Chancellor of the Exchequer, Rachel Reeves, announced that from 6 April 2027 most unused pension funds and pension death benefits would be brought within the deceased’s estate for inheritance tax (IHT) purposes.[1]

Historically, defined contribution pensions have been a widely used tool for intergenerational wealth transfer. Unlike many other assets, unused pension funds have generally fallen outside of an individual’s estate for IHT purposes and, in some circumstances, could be passed to beneficiaries free from both IHT and income tax.[2] Because of this, pensions have often been seen as a shelter for family wealth, with retirees encouraged to draw from other assets first and preserve pension savings.

These reforms represent a departure from this longstanding treatment. When first announced, one of the main concerns was that inherited pension funds could be subject to both IHT and Income Tax. This would have subsequently resulted in what many commentators described as “double taxation”. While the changes will undoubtedly increase the tax burden on some beneficiaries, the proposed legislation does include a relief mechanism designed to prevent the same value from being taxed twice in full.

It is important to note, however, that existing inheritance tax exemptions will continue to apply. For example, pension death benefits paid to a surviving spouse or civil partner will generally remain exempt from IHT, meaning the new rules will not affect all beneficiaries in the same way.

Will inherited pensions be subject to “double taxation”?

The short answer: no. In its technical note accompanying the draft legislation, HMRC acknowledged that pension death benefits could potentially be exposed to both taxes and set out measures designed to prevent beneficiaries from being taxed twice on the same value.[3]

The mechanism used to achieve this is Section 567B of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003).[4] HMRC explains that where IHT is paid in relation to pension death benefits, the portion of those benefits corresponding to the IHT paid “does not count towards the beneficiary’s taxable income”.

In other words, if part of a pension fund has already been used to pay IHT, then the beneficiary can reduce the amount of pension income subject to Income Tax by the same amount. If the available deduction exceeds the amount withdrawn in a particular tax year, the unused balance is not lost. Instead, it and offset against future pension withdrawals, subject to the rules governing the relief.

While this relief does help remove the chance of “double taxation”, it doesn’t eliminate the additional tax burden created by the reforms.

How this works in practice?

Assume the following:

• Pension fund at death: £250,000
• Member dies after age 75
• The deceased’s available nil-rate bands have been fully used elsewhere in the estate, no exemption or other relief applies, and the entire pension allocation bears IHT at 40%
• IHT attributable to the pension fund: £100,000
• The beneficiary bears the IHT liability
• The beneficiary receives the full inherited pension fund
• Section 567B deduction available: £100,000

John inherits a pension fund worth £250,000 from his father, who dies after age 75. This is important because pension benefits inherited following a death at age 75 or over can be subject to Income Tax when withdrawn by the beneficiary, in addition to any IHT that arises under the new rules. Under the new rules, £100,000 of IHT is attributable to the pension fund. Without any relief, John could be required to pay Income Tax on the entire £250,000 despite having already borne £100,000 of IHT.

Section 567B allows John to deduct an amount corresponding to the £100,000 of IHT paid from his taxable pension income.

The calculation is therefore:

• Pension fund inherited: £250,000
• Less Section 567B deduction: £100,000
• Taxable pension income: £150,000

Assuming John is a higher-rate taxpayer:

• For simplicity, assume John withdraws the benefits over a period in which the full £150,000 of taxable pension income falls within the 40% Income Tax band.
• Income Tax at 40%: £60,000

Overall outcome

• Pension fund inherited: £250,000
• Less IHT: £100,000
• Less Income Tax: £60,000
• Net amount retained by John: £90,000

Without the Section 567B deduction, John would instead have paid Income Tax on the full £250,000.

• Income Tax at 40% on £250,000: £100,000

The relief therefore saves John £40,000 of Income Tax.

Effective tax rates

With Section 567B relief:

• Total tax suffered: £160,000
• Effective tax rate: 64%

Without Section 567B relief:

• Total tax suffered: £200,000
• Effective tax rate: 80%

Some commentary on the reforms has raised concerns about the potential for inherited pension funds to be subject to both IHT and Income Tax. However, the legislation includes Section 567B relief, which is specifically designed to ensure that amounts already taken into account for IHT purposes do not also become fully subject to Income Tax.

Updated tax rates

The following illustrative figures assume that the pension amount bears IHT at 40% and that, after the Section 567B deduction, the remaining pension income is taxed wholly at the beneficiary’s stated Income Tax rate. They also assume the member dies aged 75 or over, meaning inherited pension withdrawals are subject to Income Tax.

While it’s a welcome relief (pardon the pun) that there won’t be double taxation, the revised figures still represent a fairly substantial increase in the tax burden faced by beneficiaries. You can see these changes below:

One obvious consequence of the reforms is that basic-rate taxpayers appear to face the largest increase in the effective tax rate on inherited pension wealth. Based on the above, the effective rate rises from 20% to 52% for a basic-rate taxpayer, compared with 40% to 64% for a higher-rate taxpayer and 45% to 67% for an additional-rate taxpayer.

What to do next?

It’s important to note that nothing has changed yet. While the principal legislative changes have now been enacted through Finance Act 2026, supporting regulation and guidance from HMRC is still being and finalised and these changes won’t take effect until April 2027.[5]

In saying that, this is likely to reshape how some people approach retirement and estate planning. Strategies that prioritised preserving pension wealth for beneficiaries may become less attractive, leading some retirees to reconsider their drawdown approach or explore alternatives such as gifting, trusts, and other tax-efficient structures.

The most suitable response will depend on individual circumstances, and the details of the legislation could still change before implementation. If you’re concerned about how these reforms may affect you, consider speaking to a financial adviser before making any decisions.