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For many years, pensions have been one of the most effective tools for inheritance tax (“IHT”) planning. Whilst pension savings were primarily intended to provide retirement income, they also offered a significant estate planning advantage because, in many cases, unused pension funds fell outside the deceased’s estate for IHT purposes.
This position is set to change dramatically. From 6 April 2027, most unused pension funds and pension death benefits will be brought within the scope of Inheritance Tax. This represents one of the most significant changes to estate planning in recent years and will require many individuals to review their Wills, succession planning and retirement strategies.
The Current Position
Under the current rules, many pension schemes are structured so that pension trustees or scheme administrators retain discretion over who receives death benefits following the member’s death.
Because of this discretionary structure, unused pension funds generally fall outside the member’s estate for IHT purposes. As a result, many individuals have deliberately preserved their pension funds and instead spent other assets first, such as savings and investments, in order to maximise the value passing to future generations.
What Is Changing?
For deaths occurring on or after 6 April 2027, most unused pension funds and pension death benefits will be included within the deceased’s estate when calculating Inheritance Tax. The distinction between discretionary and non-discretionary pension arrangements will largely be removed.
The Government has stated that the purpose of the reform is to prevent pensions being used primarily as vehicles for passing wealth between generations rather than for funding retirement.
The new rules will apply to:
- Personal pensions;
- Self-Invested Personal Pensions (SIPPs);
- Defined contribution pension arrangements;
- Drawdown pension funds;
- Most lump-sum death benefits.
Certain benefits will remain outside the IHT regime, including most death-in-service benefits payable from registered pension schemes.
What Impact Will This Have?
Many estates that previously fell below the IHT threshold may become liable to tax once pension funds are included.
For example:
- House: £450,000
- Savings and investments: £150,000
- Pension fund: £300,000
Total estate for IHT purposes from 6 April 2027: £900,000
Without appropriate planning, the inclusion of the pension fund could significantly increase the estate’s IHT exposure.
The Government estimates that thousands of additional estates will become liable for IHT following the introduction of these changes.
The Potential Double Tax Charge
Particular care will be required where an individual dies after age 75.
In such circumstances, beneficiaries may already be subject to income tax when drawing pension benefits. Following the 2027 reforms, the same pension fund may first be exposed to IHT and subsequently to income tax when withdrawals are made by beneficiaries.
This creates the possibility of a substantial combined tax burden.
What Will Executors Need To Do?
The administration of estates is also likely to become more complex.
Executors and personal representatives will need to:
- Identify all pension arrangements held by the deceased;
- Obtain accurate pension valuations;
- Report pension assets as part of the IHT estate;
- Calculate any IHT attributable to pension funds; and
- Liaise with pension administrators during the estate administration process.
As a result, probate applications and estate administration may become more time-consuming and administratively burdensome than under the current regime.
What Planning Can Be Undertaken During Lifetime?
The introduction of the new rules does not mean that IHT planning opportunities disappear. However, individuals may wish to review their arrangements sooner rather than later.
- Review Pension Beneficiary Nominations
Although pension funds may become subject to IHT, beneficiary nomination forms remain important and should be reviewed regularly to ensure benefits pass to the intended recipients.
- Consider Lifetime Gifts
Individuals who do not require all of their accumulated wealth may wish to consider making lifetime gifts.
Potentially Exempt Transfers (“PETs”) remain available. If the donor survives seven years from the date of the gift, the gifted assets generally fall outside the donor’s estate for IHT purposes.
- Make Use of Gifts Out of Surplus Income
The exemption for normal expenditure out of income remains a valuable planning tool.
Where gifts are made from surplus income, are regular in nature, and do not affect the donor’s standard of living, they may be immediately exempt from IHT.
- Consider Drawing Pension Benefits Earlier
Historically, many individuals chose to preserve pension funds for inheritance purposes.
Following the 2027 reforms, it may become appropriate in some cases to draw pension benefits earlier and utilise those funds during lifetime, particularly where there are opportunities to make exempt gifts or reduce the overall taxable estate.
Professional advice should always be obtained before implementing such a strategy, as income tax implications must also be considered.
- Consider Life Assurance Planning
Whole-of-life insurance policies written into trust may help provide liquidity to meet future IHT liabilities without increasing the taxable estate.
- Review Existing Wills and Trust Structures
Existing Wills drafted when pensions were expected to remain outside the estate may no longer achieve the intended tax outcome.
Individuals should review:
- Their Will;
- Pension nominations;
- Existing trusts;
- Business succession arrangements; and
- Overall estate planning strategy.
Conclusion
The inclusion of unused pension funds within the Inheritance Tax regime from 6 April 2027 marks a fundamental change in UK estate planning. For many years, pensions have been regarded as one of the most tax-efficient assets to pass on to future generations. That advantage will largely disappear from April 2027.
Individuals with significant pension savings should therefore review their estate planning arrangements as soon as possible to ensure that their assets are structured efficiently and that their beneficiaries are protected from unnecessary tax liabilities.
Professional advice should be sought before implementing any estate planning strategy, as the most suitable solution will depend upon individual circumstances, family arrangements and the value and composition of the estate.
If you are concerned about how these changes may affect your estate or your family’s inheritance, our experienced Probate & Private Client team can advise on Estate Planning, Wills, Trusts, Succession Arrangements and all aspects of Estate Administration, both contentious and non-contentious, including Probate Applications, complex estates, Inheritance Tax matters, Will Disputes, Inheritance Act claims and Executor Disputes.
Contact us today on 020 8175 6733 or enquiries@crownlawsolicitors.com to speak to our experienced Private Client solicitors.