In this year’s Autumn Budget, Chancellor Rachel Reeves announced that the majority of unspent pension funds will, from April 2027, form part of the value of an individual’s estate for the purposes of calculating Inheritance Tax (IHT).
Pension scheme administrators will become liable for reporting and paying any IHT that is due on pensions to HM Revenue & Customs (HMRC).
Whilst, currently, IHT is only paid by around 4 per cent of estates, it is estimated that 10,000 more estates will be liable to pay IHT for the first time in 2027-28, whilst approximately 40,000 will face a higher IHT bill.
In practice, what this latest measure means is that, when an individual dies, they will still be able to pass on their assets, but the remainder of their pension pot will be added to property and shares as part of a potentially chargeable estate.
For an individual affected by the change, this could mean that an unspent pension fund of £800,000 could be taxed at 40 per cent (depending on their circumstances and use of other allowances and reliefs) leading to an IHT bill on their pension alone of £320,000.
This represents a significant cost for their beneficiaries if they were to pass away after 6 April 2027.
Income Tax vs. Inheritance Tax on pension funds
As it stands, pension funds are not normally subject to IHT depending upon the age you are when you die.
If you die before the age of 75, your pension can be inherited free of tax, but if you are older than 75 your beneficiaries will pay income tax at their personal rate on the amount of your pension fund that they inherit.
Under the changes coming in April 2027, the age rules are being retained meaning that pension funds being distributed to beneficiaries will be subject to IHT and Income Tax.
It’s worth bearing in mind that if you plan to leave your pension to your spouse or civil partner, this inheritance will remain tax-free initially.
However, it will then be included in their estate when they pass away meaning other beneficiaries may still be affected at a later date.
If passing to a spouse or civil partner is not an option for you, or you would prefer to look at alternative tax-efficient strategies, it may be wise to re-evaluate your retirement and estate plans in light of these changes.
Tax planning strategies to consider
To mitigate the impact of this latest announcement, you could:
- Consider utilising pension funds sooner for personal expenditure
- Withdraw a sum of money from your pension and gift this to loved ones at least seven years ahead of your passing
- Explore alternative estate planning that may better suit your objectives and avoid unnecessary tax liabilities
Initiating conversations with your trusted advisers about estate planning, extraction of funds from investments and plans for spending these, and your personal tax affairs, as early as possible, will ensure that you have ample time to consider all of your options, and to implement tax-efficient strategies with maximum impact.
Who will be affected the most?
While this change will predominantly affect wealthier individuals, many who were not previously may now find themselves liable for IHT.
Thousands more estates will exceed the current £325,000 threshold (£500,000 if you utilise the Residence Nil-Rate Band), adding financial strain to an already challenging time.
Even where these allowances are passed to a spouse to offer up to £1 million of relief, this exemption may not be enough to cover the value of your estate once all assets – including pension funds – are accounted for.
It is also worth bearing in mind that the nil-rate bands will remain frozen beyond 2028 until 2030, which may impact upon planning.
We encourage you to revisit any estate and tax planning you have previously undertaken, with your accountant, to assess whether any adjustments need to be made before 2027.
A proactive approach will help you to ensure that you are prepared well in advance and stand you in good stead to minimise any unintended tax burdens.
If you are concerned about how this change may affect your estate, please contact our team of specialists for advice tailored to your unique situation.
We can support you with everything from tax and estate planning, to documenting your wishes for inheritance in a valid Will.
GH Probate is the trading style of GH Probate Limited. Registered in England and Wales number 9630102. Registered Office: St George’s House, George Street, Huntingdon, Cambridgeshire, PE29 3GH. Authorised to carry out the reserved legal activity of non-contentious probate in England and Wales by the Institute of Chartered Accountants in England and Wales.
GH Wills is the trading style of GH Wills Limited. Registered in England and Wales. Company Number: 15577357. Registered office: St. George’s House, George Street, Huntingdon, Cambridgeshire, PE29 3GH.
