Missed the last post of our Inheritance Tax series? Read the previous article here:Inheritance Tax Bill Gifting Options: Outright Gifts vs Trusts.
For many years, pensions have been one of the most tax-efficient ways to pass on wealth. Most people didn’t realise it, but pensions acted like a “shield”, sitting outside the estate for inheritance tax (IHT) purposes. That landscape is about to change dramatically.
From 6th April 2027, most unused pension funds and pension death benefits will be included in the value of your estate for inheritance tax. This is one of the biggest changes to estate planning in recent memory, and it means many families who have never worried about IHT before may suddenly find themselves exposed.
1. What’s Changing in April 2027?
Under current rules, most unused pension funds and death benefits fall outside of the estate for inheritance tax. This includes most defined contribution pensions such as SIPPs, workplace pensions and personal pensions. Additionally if you pass away before 75, any withdrawals your beneficiaries take will also be free of tax. If you pass away after 75, whilst the funds are not subject to inheritance tax, they are subject to income tax at the beneficiaries marginal rate when they take a withdrawal.
From April 2027 however, this is all set to change and your unused pension funds will be added to your estate for the inheritance tax calculation. This is made potentially worse by the fact that the income tax on beneficiaries should you pass away after 75 will also remain creating a possibility of double taxation.
2. Why Is This Happening?
The government has stated that pensions were increasingly being used as a way to pass on wealth tax-free, rather than simply fund retirement. By bringing pensions into IHT, the government aims to create consistency between pensions and other forms of wealth and discourage using pensions purely as inheritance vehicles when they should be a vehicle for providing retirement income.
3. Which Pensions Are Affected?
Most defined contribution pensions are going to be affected. This includes any funds or asserts remaining in your SIPP, Personal pension or workplace pension. If you have an annuity with a guarantee period, this will also be included in the inheritance tax calculation. It should be noted that many defined benefit (sometimes known as final salary) pensions are not affected.
This means the biggest impact will be for individuals with substantial defined contribution pension savings.
4. How Could This Affect Your Estate?
Your pension now adds to the total value of everything you leave behind. This matters because inheritance tax is based on the total value of your estate, not individual assets. A key issue being faced by many clients is that of the Residence Nil-Rate Band (RNRB) taper.
From 2027, pension wealth will also count towards the threshold where the RNRB begins to reduce. As detailed in a previous news letter, the RNRB reduces at £1 for every £2 the estate is over £2 million. this means that not only is the pension now subject to inheritance tax at 40% but for some the inheritance tax allowance is being reduced and more of the none pension estate is now also subject to inheritance tax.
5. Practical Challenges for Families
Some pensions include illiquid assets, such as commercial property. Beneficiaries may struggle to sell assets quickly enough to meet the six-month deadline for paying inheritance tax.
This could create cash-flow problems or pressure to sell assets below true market value creating financial stress during an already difficult time. This makes planning ahead even more important.
6. The Bottom Line
As you will now be aware, from April 2027, pensions will no longer act as the inheritance-tax-free shelter they once were. Most unused pension funds will be included in your estate, and this change could substantially increase the tax your beneficiaries pay.
The good news however, is that there are still many planning options available. The best results usually come from acting early and getting a good financial plan in place, so that when you pass away, your estate is in the best position it can be.
As part of your ongoing financial planning, we will continue to review how these changes will impact you and provide advice on how your inheritance tax can be addressed through the use of gifts, trusts and life cover.
If you have any friends, family members, or colleagues who might also benefit from understanding how their estate planning needs may have changed with the changes to pensions, please feel free to pass this information on. We’re always happy to help them review their position and explore their options.
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