Inheritance Tax And Pensions Explained

Inheritance Tax and Pensions explained: How the rules are changing

Inheritance Tax (IHT) has always been a key consideration for families looking to pass on their wealth. Traditionally, pensions have played a unique role in estate planning because, in most circumstances, they fell outside of IHT. This position is now set to change, and from 6 April 2027, pensions will be included in the value of an estate for Inheritance Tax purposes. Ashley Partridge, Partner and Head of our Wills, Probate and Estate Planning department, explains more about the current rules relating to pensions, what is changing and how you can prepare now.

How pensions are treated under the current rules

For many people, their pension is one of their most significant assets. This means the reform could bring more estates above the IHT threshold, leading to higher tax bills for beneficiaries.

At present, most defined contribution pensions do not form part of a person's estate for Inheritance Tax purposes. This makes them highly efficient from a tax planning perspective:

• If you die before the age of 75, pension death benefits can usually be paid to your beneficiaries completely free of tax.
• If you die after the age of 75, your beneficiaries will usually pay income tax on any withdrawals they take, but no Inheritance Tax.

This approach has made pensions an attractive way of preserving wealth and ensuring funds can be passed to children or grandchildren in a relatively tax-efficient way.

What will change for pensions and Inheritance Tax from April 2027

From 2027, the landscape changes significantly as any unused pension savings will be included in the total value of an estate for IHT purposes. In practice, this means:

• Transfers to a surviving spouse or civil partner remain exempt from IHT.
• Transfers to anyone else, such as children, grandchildren, or other relatives, may now attract a 40% IHT charge on the value above the available nil-rate bands.
• Families could face not only the loss of part of the pension to IHT, but also the possibility of income tax being applied if the recipient makes withdrawals.

This double layer of tax could substantially reduce what loved ones eventually receive.

Why the changes to pensions in 2027 matter

It is estimated that this reform will bring tens of thousands more estates into the IHT net. For some families, the additional liability could amount to tens of thousands of pounds. Those with pensions containing illiquid assets, such as commercial property, face an added challenge of raising funds to pay the tax without being forced into a quick sale at an unfavourable time.

It also represents a shift in how pensions are viewed. For many, pensions have been seen as a way to pass wealth down generations. Now, they will need to be considered alongside other assets when planning how best to provide for family members.

How can you prepare now for the changes to pensions in 2027

With careful planning, you can reduce the impact of these changes as early action gives you more flexibility and options.

The inclusion of pensions in Inheritance Tax calculations means your estate planning will benefit most from a joined-up approach. We will look at your situation from every angle, making sure that your legal arrangements and your financial plans work together.

We can:

• Review and update your Will to make sure it reflects these changes and protects your loved ones.
• Advise on, and set up, Trusts or other structures that can help reduce the impact of Inheritance Tax.
• Support your Executors with their responsibilities and guide them through the reporting process when the time comes.
• Work closely with your financial adviser so that the legal documents we prepare complement the financial strategies they recommend.

We can help you explore the options available, whether that means considering lifetime gifting, drawing more from your pension during your lifetime, or using Trusts and other planning tools, so that your estate passes on in the way you intend.

Additional considerations for your pension when estate planning

When planning ahead, it is important to keep the following points in mind:

• It may be worth considering whether to take more from your pension during your lifetime, although this will depend on your personal circumstances and income tax position.
• Any change in how assets are taxed should trigger a review of your Will to ensure it still reflects your wishes.

Contact our Wills, Probate and Estate Planning Solicitors today

While 2027 may feel some time away, estate planning works best when it is proactive. Leaving it until the last minute may limit your options and leave your family with an avoidable tax bill.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.