The UK government’s upcoming changes to inheritance tax (IHT) have sparked warnings from financial experts, especially for people planning to pass on pensions or large estates. A key change arriving in July 2027 will count defined contribution pensions as part of your taxable estate—potentially triggering thousands in unexpected taxes unless you act now.
One underused strategy that could help reduce future tax bills is the “gifts out of surplus income” relief. Surprisingly, only a small number of estates have claimed this powerful exemption, even though it can shield large amounts of money from the 40% inheritance tax charge.
Changes
Here’s what’s changing with pensions and inheritance tax from 6 July 2027:
| Detail | Before July 2027 | After July 2027 |
|---|---|---|
| Pension IHT Status | Unused pensions excluded from IHT | Pensions included in taxable estate |
| IHT Rate | 0% on pension (if died before age 75) | 40% over threshold if estate exceeds allowance |
| Example | £500k pension passed tax-free | Pension taxed as part of estate |
This change mainly affects defined contribution pensions like workplace pensions or SIPPs. If you’ve saved money in a pension and don’t use it before you die, your loved ones could be left with a large tax bill.
Example
Let’s say John dies in 2028 with the following assets:
- Home: £400,000
- Savings: £100,000
- Pension: £500,000 unused
Before July 2027: Only the home and savings are taxed under IHT. If passed to direct descendants, John is under the £500,000 allowance and pays no IHT.
After July 2027: The full £1 million estate is now taxable. He’s £500,000 over the nil-rate band and could face an IHT bill of up to £180,000.
Relief
This HMRC exemption allows individuals to give away regular gifts from income, not capital, without triggering inheritance tax. And unlike the £3,000 annual gift allowance, there’s no upper limit.
To qualify:
- Gifts must be regular (monthly, annually, or similar)
- They must come from income, like pensions, dividends, or rent
- You must still have enough left over to maintain your lifestyle
Common Examples
- Sending £1,000/month to adult children
- Paying school fees for grandchildren
- Covering rent or household bills for family
Provided it’s done regularly and recorded, these gifts are fully exempt from IHT—no matter how large.
Statistics
| Stat | Value |
|---|---|
| Standard IHT Nil Rate Band | £325,000 |
| IHT Threshold with Residence Nil Rate | £500,000 |
| For Married Couples | Up to £1 million |
| Estates using Surplus Income Relief (3 years) | Just 1,490 |
With so few using this strategy, many are missing out on a huge opportunity to cut down future tax bills.
Steps
- Review Your Income and Spending
Add up income from pensions, dividends, etc., then subtract your expenses. Anything left is your surplus. - Choose Gifts to Make Regularly
Decide how you want to help—supporting kids, paying for a wedding, covering education costs, etc. - Keep a Written Record
Note each gift’s date, amount, purpose, and income source. Use spreadsheets or HMRC’s IHT403 form to formalise it. - Let Family Know
Tell your loved ones you’re doing this so they can reference it if HMRC reviews your estate later. - Get Financial Advice
A tax planner can help structure your gifts properly and avoid costly mistakes.
Tips
- Not well advertised – Many don’t know it exists
- Documentation required – Must show the gifts are regular and from surplus income
- Assumptions about wealth – People think only the very wealthy can use it
But that’s not true. Even modest regular gifts from income can qualify—so long as you keep proper records.
Other
Additional Inheritance Tax Reliefs You Should Know
| Relief | Description |
|---|---|
| Annual Exemption | Gift up to £3,000 per year without IHT |
| Small Gifts Exemption | £250 per person to as many individuals as you like |
| Wedding Gifts | £5,000 to children, £2,500 to grandchildren for weddings |
| Business Relief | 50% to 100% IHT relief on business assets |
| Charity Donations | Tax-free gifts to UK-registered charities |
Used alongside surplus income gifting, these can help you reduce your taxable estate significantly.
FAQs
When will pensions face inheritance tax?
From July 6, 2027, defined contribution pensions will be taxable.
What is the IHT rate on estates over the threshold?
40% is charged on assets above the nil-rate band.
Is there a limit to gifts from surplus income?
No, as long as gifts are regular and from income.
Do I need to report gifts from surplus income?
Yes, keep records and use HMRC Form IHT403.
Can pension gifts still be tax-free before 2027?
Yes, if death occurs before 75 and before July 2027.
