Pension Funds and Inheritance Tax: Important Changes
Chris Broome – Chartered Financial Planner
From 6 April 2027, inheritance tax (IHT) rules will undergo significant changes, bringing most pension funds within the scope of estate taxation.
This will affect funds distributed as lump sums, beneficiary’s drawdown payments, and annuities.
Under current rules, most pension funds sit outside the estate as payments are made at the pension scheme’s discretion.
The upcoming changes will eliminate this distinction between discretionary and non-discretionary payments, meaning the value of all benefits will become part of the taxable estate.
According to the Government’s consultation paper, IHT liability will be calculated based on the gross value of pension funds immediately prior to death, before any distribution or beneficiary designation occurs.
The existing income tax framework for pre and post age 75 death benefits will remain in place. This creates a situation where post-75 death benefits, or funds exceeding the LSDBA before age 75, will incur both IHT and income tax on the remaining amount.
Implementation will require close cooperation between personal representatives and pension scheme administrators/trustees to determine the IHT charge and calculate the scheme’s portion of that charge.
The standard spousal exemption will continue to apply, ensuring that funds transferred to a spouse or civil partner remain IHT-free upon first death.
With the implementation date set for 6 April 2027, there is sufficient time to thoroughly evaluate these changes and develop appropriate client advisory strategies.
It’s worth noting that given the complexity of implementation and the potential severity of ‘double taxation’ for deaths occurring after age 75, modifications to these rules may occur before they take effect.
Key Considerations for pension savers:
- Evaluate the suitability of pension funding where you have been using pensions primarily as estate planning vehicles.
- Review scenarios where you have postponed taking tax-free cash beyond age 75. Taking tax-free cash now would ensure only IHT applies on death, avoiding combined IHT and income tax liability.
- Reassess situations where pension funds remain undrawn mainly for estate planning purposes, particularly for clients over 75.
- For unused pension funds, consider recommending tax-free cash withdrawal and gifting as a more advantageous strategy compared to retaining funds in the pension.
- Conduct comprehensive reviews of death benefit nominations. Spousal transfers may provide additional opportunities to reduce estate value before second death.
- Consider binding nominations, as their primary disadvantage will be eliminated. However, be aware that schemes may need time to update their rules accordingly.
- Don’t overlook bypass trusts for death benefits. While they won’t avoid IHT on first death, they can keep funds outside the estate on second death.
Questions?
Please get in touch if you have any questions about the above or what it might mean for your financial plans.
Please note:
The content of this blog is intended for general information purposes only.
