In the Autumn 2024 Budget, Chancellor Rachel Reeves announced a significant shift in how pensions will be treated for inheritance tax (IHT) purposes. From 6 April 2027, most unused pension funds and death benefits will be included in the value of a person’s estate for IHT. This marks a major change in estate planning strategy for UK investors and retirees.
what's changing?
Currently, pensions are typically excluded from IHT calculations, especially when held in discretionary schemes or trusts. This has made pensions a popular tool for passing on wealth tax-efficiently.
However, from April 2027:
- Unused pension funds and death benefits will be included in the estate for IHT purposes.
- Personal Representatives (PRs) will be responsible for reporting and paying any IHT due on these pension assets.
- Death-in-service benefits and pensions passed to a spouse, civil partner, or registered charity will remain exempt from IHT.
- Pension scheme administrators will support PRs through a new Pension Inheritance Tax Payments Scheme.
Why Is This Happening?
The government aims to:
- Close loopholes where pensions were used as intergenerational wealth transfer vehicles.
- Encourage pension drawdown during retirement rather than leaving large untouched pots.
- Raise revenue, with estimates suggesting an additional £3.44 billion by 2030.
Who Pays the Tax?
Initially, the government proposed that pension scheme administrators would pay the IHT. However, after industry feedback, this was revised:
- Personal Representatives will now handle IHT reporting and payment.
- Beneficiaries may be jointly liable for the tax once funds are distributed.
- There are three main options for payment:
- Beneficiaries pay IHT to PRs.
- Beneficiaries instruct pension administrators to pay IHT directly.
- PRs pay from the estate and recover from beneficiaries later.
Double Taxation Concerns
If the deceased was 75 or older, beneficiaries may also pay income tax on inherited pension funds. HMRC has confirmed mechanisms will be introduced to offset IHT against income tax, but this may still result in effective tax rates of up to 67% in some cases.
Planning Ahead: What Should You Do Now?
To mitigate the impact of these changes, consider:
- Reviewing your pension nominations and 'expression of wishes'.
- Consolidating pension pots to simplify estate administration.
- Drawing down pension funds earlier to reduce unused balances.
- Using pensions to fund life insurance to cover future IHT liabilities.
- Seeking advice on trusts or gifting strategies to reduce your taxable estate.
Who Will Be Affected Most?
- Individuals with large pension pots who planned to leave them untouched.
- Unmarried couples, where pension death benefits may now be taxed.
- Estates approaching or exceeding the £325,000 IHT threshold (or £500,000 with residence nil-rate band).
Next Steps
The inclusion of pensions in IHT calculations from April 2027 is a fundamental shift in financial planning. Whether you're approaching retirement or already retired, now is the time to review your strategy.
Book a free discovery meeting with one of our Chartered Financial Planners to explore how these changes could affect your estate and what you can do to protect your legacy.
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