Inheritance tax on pensions: Understanding the proposed changes and planning ahead

Amongst the changes announced by Rachel Reeves in her Autumn Budget were the intention that from April 2027 pension policies would become subject to Inheritance Tax, leaving many potentially having to review their estate planning. 

Under current legislation, if an individual had made contributions to a Defined Contribution (DC) pension scheme and died above age 75 this pension fund could be paid to beneficiaries, often either as a lump sum death benefit, or if scheme rules allow, as a type of pension income. Crucially, this DC pension falls outside of the estate for inheritance tax purposes. As in this example the policyholder died over age 75 income tax will be due on any lump sum or pension paid to the beneficiary. This will ordinarily be deducted by the Pension Scheme Administrator at the recipient’s marginal rate from payments when they are made. 

From April 2027 the proposal is to include the value immediately before death of the DC pension within the estate for inheritance tax purposes. To put into perspective what this can mean to individuals; if an individual has an estate of £1M in addition to a DC pension fund of £400,000 their estate for IHT would be £1,400,000 from which the nil rate band of £325,000 is deducted leaving £1,075,000 from which IHT of 40% would be charged. This would equate to £430,000 of IHT due which is £160,000 more than would be the case under the current rules. 

In this example the Personal Representative would be liable for £307,143 which is paid from the non-pension element of the estate. The Pension Scheme Administrator would be liable for the remainder £122,857. When deducted from the pension fund, previous valued at £400,000 this would leave £277,143 to the non-spouse beneficiary who could decide how to split between a lump sum or pension income. As at present, if needed the Pension Scheme Administrator will also deduct Income Tax at the grandson’s marginal rate when payments are made. These rates could also vary depending on how the grandson takes the benefits. 

As this example highlights, revisiting your estate planning is key, remembering this proposed change is subject to consultation and will not come into effect until April 2027. Pensions remain an attractive home for your retirement provisions, with no changes to tax-relief on contributions or the taxation of lifetime benefits.

To discuss your own personal circumstances please contact our Financial Planning team on +44 (0) 330 124 1399 or provide your details via our online enquiry form. 

The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice. You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.