By *The Barrister*
The UK government’s forthcoming 2027 inheritance tax (IHT) reforms for pensions have ignited debate among financial advisers, wealth managers, and savers. At the heart of the controversy lies a fundamental question: will imposing a 40% inheritance tax on untouched pension pots undermine the culture of long-term saving that successive UK governments have sought to encourage?
Background: The New IHT Rules for Pensions
From April 2027, unused funds within defined contribution pensions—including Self-Invested Personal Pensions (SIPPs)—will be brought into the taxable estate on death and subject to the standard 40% IHT on amounts exceeding the available nil-rate band. This marks a major departure from the current system, under which, in many cases, unused pensions could be passed to beneficiaries free from UK IHT.
The government’s stated aim is to align the tax treatment of pension savings with that of other assets, closing perceived loopholes and boosting IHT receipts. However, critics argue that this change will reshape not only how individuals manage their retirement savings but also the nation’s broader approach to saving and investment.
Incentives for Pension Saving: Built on Trust and Policy
For decades, the UK has promoted tax-advantaged pension saving as a social good: a way for workers to ensure financial independence in retirement and, where possible, provide for their families. The promise was simple—those who saved diligently would be rewarded. Historically, the absence of IHT on unspent pension funds was a cornerstone of that policy framework.
From Incentive to Disincentive: The Unintended Consequence
By removing pensions’ IHT exemption and drawing untouched savings into the IHT net, the government has changed the calculation for many savers. Particularly for those with larger pots or intergenerational intentions, the new rules introduce a punitive 40% IHT risk that may drive very different behaviour among retirees.
Accelerated Withdrawals: The New Normal?
A likely consequence of the 2027 reforms will be a rise in retirees crystallising and withdrawing their pension assets earlier. Rather than leaving funds invested for the long term and passing them on, many will draw down or gift their savings during their lifetime—even at the cost of paying income tax at higher rates. Such ‘decumulate to accumulate’ strategies may protect families from IHT but risk weakening the UK’s national savings base.
Erosion of the Intergenerational Compact
Perhaps the most profound impact lies in the erosion of intergenerational wealth transfer. For families hoping to support their children or grandchildren, pensions were one of the most efficient IHT-free vehicles. By taxing unspent pensions, the government sends a clear message: pensions should be consumed, not conserved. This risks fracturing the long-standing compact between generations that underpinned the UK’s savings culture.
The Government’s Rationale: Fairness and Fiscal Integrity
Supporters of the reform argue that pensions were designed to provide income in retirement, not serve as inheritance shelters. They contend that aligning IHT rules for pensions with those for property and investments promotes fairness across asset classes. From a fiscal standpoint, integrating unspent pensions into estates may generate additional revenue to support an ageing population and the sustainability of public finances.
Policy Backfire? Fiscal and Economic Risks
Ironically, the government’s revenue goals may be undermined by the behavioural changes these reforms induce. If retirees accelerate withdrawals and spend down their savings, future IHT receipts could fall even as near-term income tax rises. The result may be a smaller pool of invested pension capital, with long-term consequences for economic stability and growth.
Impact on the UK Savings Culture
The psychological consequences of this policy shift could be severe. Trust in the pension system depends on perceived fairness and predictability. When policy changes impose new taxes on assets previously considered protected, confidence can erode rapidly. The likely outcome: less saving, more immediate consumption, and potentially greater reliance on state support in later life.
Strategic Responses: Planning in the IHT Era
Financial advisers are already revising their recommendations to mitigate exposure: staggered withdrawals to manage income tax bands, lifetime gifting strategies, and, for international families, considering offshore structures. Yet none of these options match the simplicity and efficiency of the pre-2027 system.
Conclusion: A Question of Long-Term Policy Vision
The 2027 IHT pension reforms may advance the appearance of tax equity, but they risk damaging a cornerstone of the UK’s savings culture. By taxing unspent pensions so heavily, the government could inadvertently encourage consumption over prudence, and short-term gain over intergenerational stability. A more balanced approach—perhaps a tapered IHT charge or exclusion thresholds—could preserve fairness while safeguarding the culture of saving that underpins economic security.
This article is for general informational purposes and does not constitute financial or tax advice. Readers should seek professional guidance for advice relevant to their individual circumstances.
References:
[1] Royal London. *Changes to inheritance tax (IHT) on pensions from 2027.*
[2] Gov.uk. *Inheritance Tax on unused pension funds and death benefits.*
[3] Mike Coady. *UK Inheritance Tax Set to Hit Pension Funds from 2027.*
[4] Frazer James. *SIPPs Explained: Contributions, Withdrawals & Tax-Free Benefits.*
