Robert Keyse, in our Wills, Probate, Tax & Trusts team, explain the upcoming changes to Inheritance Tax in relation to pensions, and what steps individuals can take to prepare for the new rules coming into force.
What is Inheritance Tax and what are the current rules?
Inheritance Tax (IHT) is a tax on the estate of a person who has died, including all property, possessions and money.
Currently, as has been the position for many years, the majority of pension schemes fall outside a person’s estate for IH purposes. The usual structure is that the funds are effectively held in Discretionary Trusts and are distributed post death by the Trustees of the fund in accordance with an “expression of wish” or “nomination” form.
As a consequence, pension funds have traditionally been an important part of succession planning for high net worth individuals and their families. In situations where a surviving spouse or civil partner might not need provision from the pension fund the funds can be moved down a generation to children or even to grandchildren free of IHT.
Please see our blog article, ‘What is Inheritance Tax and Will It Be Payable on My Estate When I Die?’ for further information on Inheritance Tax, IHT exemptions and Trusts.
How are Inheritance Tax rules changing and how will this affect pensions?
From 6 April 2027, any unused pension funds (i.e. uncrystallised and/or residual funds not yet in drawdown or annuitized) will be brought into the valuation of a deceased individual’s estate. Government estimates suggest that this change will result in 10,500 estates paying IHT for the first time in 2027/28; 38,500 more will see their bills increase (by around £34,000 on average) and an estimated additional £1.46 billion a year will be raised in IHT by 2030. This move by the Government aligns the tax treatment of discretionary pensions schemes with other forms of inherited wealth that are subject to IHT and closes the tax loophole allowing pensions to be used as a tax planning tool rather than as a means of funding one’s retirement.
Considerations and consequences
Aside from the initial IHT charge, there are other consequences arising from the proposed pension and IHT reforms.
If you die after the age of 75 beneficiaries are currently liable for Income Tax at their marginal rate on withdrawals. This is not changing so potentially under the new rules there could be a double charge.
Bringing the value of the pension pot into the Estate may push the value of estates over the £2million threshold, potentially reducing or eliminating the Residence Nil Rate Band (RNRB) allowance and increasing the overall IHT liability.
Responsibility for reporting and paying the IHT rests with the Executors, not the pension providers. Pension scheme administrators will therefore need to provide information about the value of any unused pension funds in a timely manner and both parties will need to work together to ensure the IHT is paid on time. Guidance is awaited from HMRC in terms of the system which will be put in place to pay the tax liability.
Responsibility for reporting and paying the IHT rests with the Executors, not the pension providers. Pension scheme administrators will therefore need to provide information about the value of any unused pension funds in a timely manner and both parties will need to work together to ensure the IHT is paid on time.
The impact of this change will be seen in a shift in strategy for financial planning with the long-standing advice to “spend other assets first” and leave the pension untouched no longer being applicable. Pension death benefit nominations should be reviewed and professional financial advice sought as to whether other assets like ISAs or property should play a bigger role in retirement income.
Advice and guidance
If you believe that these changes may affect you and your Estate, it is worth considering seeking further advice regarding Estate planning. This will allow you to review how your assets are structured, explore the use of Trusts and make full use of the available exemptions and gifting allowances to help reduce your taxable Estate.
Our Wills, Probate, Tax & Trusts team can advise on Estate Planning, tax and Trusts.
For further information or legal advice, please contact law@blandy.co.uk or call 0118 951 6800.
This article is intended for the use of clients and other interested parties. The information contained in it is believed to be correct at the date of publication, but it is necessarily of a brief and general nature and should not be relied upon as a substitute for specific professional advice.
