Thousands more families could be drawn into inheritance tax (IHT) from April 2027, when defined contribution pensions are reclassified as part of a deceased person’s estate for the first time. The change, announced in the 2024 Budget, is expected to double the number of estates liable for IHT to around 8%, according to government figures. For those who have remarried or are in blended families, the shift adds a fresh layer of complexity to estate planning that many may not have considered.
Inheritance tax changes on the horizon
From 6 April 2027, most unused pension funds and death benefits from defined contribution (DC) schemes will be included in the estate for IHT purposes. This marks a significant departure from the current position, where such pensions typically fall outside the estate. The standard nil-rate band (NRB) of £325,000 has been frozen since April 2009 and is confirmed to remain at that level until at least April 2031. The residence nil-rate band (RNRB), currently £175,000 and available when passing a family home to direct descendants including stepchildren, is also frozen over the same period. Taken together, a married couple or civil partners can transfer unused allowances between them, meaning they could potentially pass on up to £1 million IHT-free — £650,000 from the combined NRB and £350,000 from the combined RNRB — provided the estate qualifies.
The change primarily affects defined contribution pensions. Defined benefit schemes, such as final salary pensions, are generally not expected to be caught because they cannot typically be passed on. Death-in-service benefits paid from registered pension schemes and certain dependants’ pensions from defined benefit arrangements are also expected to be excluded. Personal representatives — the executors or administrators of an estate — will be responsible for reporting and paying any IHT due on pension assets, rather than the pension administrator.
The spousal exemption remains intact: transfers between UK-domiciled spouses and civil partners are exempt from IHT with no upper limit, and the same applies to pension funds left to a surviving spouse or civil partner. Charitable legacies also continue to attract exemption. However, once pension wealth is included in the estate valuation, any amount above the available allowances may be taxed at 40%. For families with significant pension pots, the potential IHT bill could be substantial.
Blended families and the risk of disinheritance
The timing of these rule changes coincides with a notable demographic shift. According to the Office for National Statistics (ONS), marriage rates among the over-50s have risen sharply over the past decade. The number of men aged 50 or older who married increased by 33% in the ten years to 2022; for women in that age group the increase was 47%. The figures are even more pronounced among people in their sixties, with a 33% rise for men and a 56% rise for women over the same period. Later-life marriages — whether a first, second or subsequent union — often bring children from previous relationships. The ONS estimates that between 10% and 33% of families in the UK are blended, defined as at least one child having a parental relationship with both members of the couple and another child being a stepchild.
Stepchildren do not have automatic inheritance rights under intestacy laws, a point underlined by the research briefing. If a person dies without a will, only a spouse, civil partner, children and certain other blood relatives inherit by law — stepchildren are excluded. This makes clear documentation of wishes essential. Andrew Zanelli, head of technical engagement at investment platform Aberdeen Adviser, warns of a potential “nomination minefield” once pensions become subject to IHT. The key question for blended families, he says, is whether pension assets should pass to a surviving spouse or directly to children from a previous relationship.
Leaving everything to a husband or wife has obvious attractions. Pension wealth passing directly to a surviving spouse or civil partner benefits from the interspousal exemption and is not subject to IHT on first death. But the risk is that the surviving spouse may subsequently change their will or nomination forms, cutting out the first spouse’s children — whether through remarriage, falling out with the children, or simply changing priorities over time. Zanelli gives a stark example: “Let’s assume the husband dies first. By nominating his wife, he is effectively handing over future control of his pension pot to her. She could change her nominations at any time in favour of other individuals, cutting out his own children. This could be motivated by remarrying someone else, or falling out with his children.”
On the other hand, leaving assets directly to children from a previous relationship presents a different problem. Any amount above available allowances may attract IHT immediately, and the surviving spouse may have no access to those funds if they need them for housing, care or everyday expenses. Balancing the needs of a surviving spouse and children from previous relationships requires careful planning to avoid disputes and unintended disinheritance.
The role of trusts in estate planning
Trusts are a common mechanism for managing these competing interests. Every trust involves three key parties: the settlor, who provides the assets; the trustee, who manages them; and the beneficiaries, who ultimately benefit. Assets that can be placed into trust include cash, property, investments and land. In the UK, several trust structures are available.
Lifetime trusts take effect immediately and include bare trusts, vulnerable person’s trusts and personal injury trusts. Will trusts are created through a will and only take effect on death; examples include discretionary will trusts and pilot trusts, which can hold assets such as pension death benefits or life insurance payouts.
Interest in possession trusts — often called life interest trusts — allow a surviving spouse to benefit from an asset during their lifetime without owning it outright. For example, they might have the right to live in a family home or receive investment income, while the underlying capital eventually passes to children or other beneficiaries. This can help protect assets for children from a previous relationship and may also mitigate the impact of care home costs.
Discretionary trusts offer trustees broad control over how and when assets are distributed, providing flexibility for changing circumstances. Provided the settlor lives for seven years after making the transfer, assets can fall outside their estate for IHT purposes, although periodic trust charges — typically every ten years — may still apply. Most UK trusts must also be registered with HMRC’s Trust Registration Service.
Spousal bypass trusts are a specific type of discretionary trust historically used to receive pension death benefits. Their aim is to keep those benefits outside the surviving spouse’s estate for IHT while allowing the spouse to benefit during their lifetime. The eventual beneficiaries — often children from the first relationship — receive the remaining funds after the surviving spouse dies.
Dan Blandford, chartered financial planner at The Private Office (TPO), believes two broad approaches may emerge after April 2027. The first is that some people may stop using bypass trusts altogether and leave assets directly to a spouse, trusting them to pass wealth to the intended beneficiaries later. This avoids an immediate IHT charge but relies heavily on the surviving spouse carrying out those wishes. The second scenario, he says, is more likely among wealthier families with very large pensions expected to support several generations. Rather than allowing pension wealth to pass down through successive estates and potentially attract IHT multiple times, some may choose to pay the tax once and move assets into a discretionary trust structure. “I envisage that would be the second reason it will be used; do people accept a ‘one-off’ IHT charge in exchange for avoiding repeated charges as wealth passes from one generation to the next,” says Blandford. He believes spousal bypass trusts will still have an important role for those motivated primarily by control rather than tax savings, allowing them to determine when assets or income are distributed and helping protect beneficiaries from risks such as divorce or financial difficulties.
The pension nomination dilemma
Beyond trusts, the question of whom to name as a pension beneficiary becomes critical once pensions are inside the IHT net. Paul Gotch, senior partner at Private Client Solicitors, points out that a pension is held in trust and subject to scheme rules. An individual effectively only has the power to change their expression of wish or nomination form, which tells the trustee who should receive the benefits on death. The trustee takes that guidance but it is not legally binding, meaning the ultimate decision rests with the scheme trustees.
Zanelli advises blended families to think carefully about how assets are split. “Does the spouse get the pension and any children get other assets? Are you splitting things 50/50? Have you got other children with the new spouse?” He emphasises the need to balance the legal perspective — what can be done — with the financial perspective — what is fair. “Are you leaving your spouse sufficient funds to maintain their standard of living, the cost of the property and so on. Equally, if assets go to that surviving spouse, there’s a risk that on his or her death, they update the will and nomination to only include his or her own children, which then creates the disinheritance of the first.”
Care costs add another dimension. Gotch notes it is common when a relationship is going well for the surviving spouse to “do the right thing”, but circumstances change. If the surviving spouse needs several years of expensive care, the assets intended for the first spouse’s children may be significantly depleted. No trust structure can eliminate every risk, but clear planning can help prevent disputes and uncertainty later on.
For those looking to reduce the size of a pension pot potentially exposed to IHT, several strategies exist. Spending pension assets during one’s lifetime — particularly if well-off — can lower the eventual bill. Purchasing an annuity reduces the value of unused pension funds and can provide a guaranteed income; annuity sales have increased in recent months. A whole life insurance policy set up in trust can provide funds to cover IHT liabilities without the payout itself being added to the estate. Charitable giving of 10% or more of an estate can reduce the IHT rate on the remainder from 40% to 36%, and leaving pensions to charity after 2027 may become more tax-efficient. Lifetime gifts made more than seven years before death are usually exempt from IHT, with tax reducing on a sliding scale between three and seven years.
Property ownership is another area where planning matters. Tamsin Caine, director of financial planning at Smart Financial, highlights the example of a life interest trust involving the family home. For such a trust to work, the property generally needs to be owned as tenants in common rather than joint tenants. Under joint tenancy, ownership passes automatically to the surviving spouse, bypassing the will entirely. “It’s important to revisit wills and keep them up to date, making sure they’re still in line with wishes, with legislation and that they still reflect everything that you’d want,” Caine says. She also cautions against viewing pensions primarily as an IHT planning tool. “Pensions are intended to provide income in retirement. While we know people have used them for planning for the next generation, if you’re thinking about passing down the generations – in my view, pensions should be the last thing you touch.”
The importance of professional advice is stressed by all parties. Remarrying automatically revokes an existing will, and many people still assume estate planning is only for the very wealthy, despite rising house prices and the frozen nil-rate band bringing more families into scope. Common misconceptions include believing a spouse automatically inherits everything if someone dies intestate, that pension benefits automatically fall to family members, or that unmarried couples have the same legal protections as married couples. For blended families facing a more complex IHT landscape, taking time to put clear plans in place — including reviewing pension nominations, property titles and will provisions — may help prevent disputes and uncertainty further down the line.
