Pensions and Inheritance Tax: The New Rules – What we already know

For many clients approaching retirement, pensions have not only been a key source of retirement income but also an effective estate planning tool. However, major changes to the inheritance tax (IHT) rules announced in the Autumn Budget 2024 will significantly alter this position from 6 April 2027. Read the Government’s consultation here Technical consultation – Inheritance Tax on pensions: liability, reporting and payment – GOV.UK

Currently, most defined contribution pension funds (also known as money purchase schemes) fall outside an individual’s estate for IHT purposes. This has made them a popular way to pass on wealth to children or other beneficiaries in a tax efficient way. The pension pot is typically held in a discretionary trust, which means it is not treated as part of the estate on death and is not subject to the usual IHT calculation and charges.

From April 2027, this exemption will end. Pension death benefits will be included in a person’s estate when calculating IHT. This change is expected to have a broad impact, particularly for those who had planned to leave their pension untouched in retirement and pass it on as an inheritance.

How Will the New Rules Work?

While consultations are still ongoing within Government to complete the technical procedures and guidance, we currently understand the major changes will include the following:

• Any unused pension funds on death will be added to the rest of the estate.
• The IHT nil rate band (the inheritance tax free threshold for an individual, which is currently £325,000) and the residence nil rate band (available to individuals passing a house to children or other lineal descendants, up to £175,000) will be shared between the person’s pension fund and their free estate (other estate assets).
• The IHT attributable to the pension fund will be paid by the pension scheme administrator, who must work with the deceased’s personal representatives to settle the liability.

Income tax plus Inheritance Tax

Surprisingly, the existing income tax charge on pension death benefits will remain. This means that beneficiaries may face both an IHT charge and income tax at their own personal income tax rate on the same sum, potentially resulting in an effective tax rate of up to 60%.

What should you do?

These changes may mean pension funds are no longer the most efficient way to pass on wealth. However, it’s important to emphasise that decisions around pensions should only be made with the benefit of regulated financial advice. Our role as legal advisers is to ensure your estate planning is structured around your personal objectives and is aligned with the evolving tax landscape.

You should seek professional financial and legal advice on aspects including:

• Reviewing pension death benefit nominations, particularly where children are named as beneficiaries.
• Consider whether death benefit allocations might be more tax-efficient if directed to a spouse, where spousal exemptions apply.
• Be aware that pension funds being added to your taxable estate now means your estate could be significantly higher value than before. You may now be closer to the £2 million threshold at which the residence nil rate band begins to taper, potentially reducing valuable IHT reliefs which were previously available.

To review your will, estate planning or your pension nominations, please contact our private client team to arrange a consultation.

If you do not currently have a financial adviser, we can help you find a trusted, regulated professional who can provide the appropriate pensions advice.