Metis AM
For years, pensions have held a unique and favourable position within the UK’s Inheritance Tax (IHT) landscape.
Pensions are often seen as a tax-efficient way to transfer wealth to loved ones, as wealth held in pensions is currently exempt from IHT. However, this could soon change.
With new legislation set to take over from April 2027, the pension and IHT landscape could change significantly for thousands of estates across the UK.
So, it could be crucial to fully understand what these changes mean and what you need to consider for your estate planning strategy.
Current Inheritance Tax rules have a pension “loophole”
Under the current rules, most pension pots are largely exempt from IHT. This is because they typically fall outside of your taxable estate.
In cases where tax is payable, it will depend on the following:
- The type of payment received
- The type of pension pot inherited
- The age of the pension pot’s owner when they died.
In terms of age requirements, the following applies:
- If the pension holder dies before the age of 75, any remaining funds can usually be passed down to their beneficiaries tax-free, provided the funds are paid out within two years.
- If the pension holder dies at or after the age of 75, then their beneficiaries will likely need to pay Income Tax on any withdrawals made from the inherited pension. This will be taxed at their marginal rate.
Notably, no IHT will be due on the pension pot itself.
This has made it possible for many to leave their pension funds relatively untouched, choosing to draw a retirement income from other assets. This has, in effect, created a “loophole” for the transfer of wealth.
From April 2027, unused pension funds and other death benefits could become eligible for Inheritance Tax
In its Autumn 2024 Budget, the Labour government announced plans to include unused pension funds and certain death benefits within the value of a person’s estate for IHT purposes. Though this may still change, it is currently set to take place from 6 April 2027.
Labour cites this change as a way of addressing a perceived tax advantage for wealthier households.
Under the proposed rules:
- Unused pension savings will form part of your estate for IHT purposes. This means that regardless of your age at death, any remaining pension funds will automatically become part of your overall estate for IHT calculations.
- There is a potential for “double taxation”. If the pension holder dies at or after age 75, their beneficiaries could face Income Tax on the withdrawals and an initial 40% tax bill on the portion of the pension that exceeds the IHT nil-rate band.
It’s important to note that certain exemptions are expected to remain. For instance, pension death benefits paid to a spouse or civil partner are likely to still be exempt from IHT, provided they are UK domiciled.
Understanding Inheritance Tax thresholds remains crucial
The proposed changes to pensions and IHT are significant, particularly when you consider that the current IHT thresholds are frozen until April 2030.
As of the 2025/26 tax year, these are:
- The nil-rate band. Here, the first £325,000 of your estate is exempt from IHT.
- The residence nil-rate band. An additional £175,000 allowance is available if you pass your main residence on to your direct descendants.
This means that, as an individual, you could pass on up to £500,000 of your estate tax-free.
Remember, married couples and civil partners can transfer any unused thresholds to their surviving partner, which means you could potentially pass on up to £1 million to your loved ones tax-free.
Despite these allowances, the frozen thresholds combined with rising asset values and the inclusion of pensions into estates mean that more people will become liable for IHT.
The BBC reports that, as of 2024, 27,800 estates pay IHT. This amounts to just over 4% of estates.
However, the BBC also explains that economists from the Institute for Fiscal Studies believe that around 7% of estates could be liable for IHT by 2032.
Fortunately, there are actions you could take to help mitigate your IHT liability.
Your options for estate planning will depend on your particular circumstances
While the full details of the upcoming changes are still being finalised, you might have several options available to you to help mitigate your IHT liability.
- Review your pension strategy. You might want to consider alternate drawdown or savings strategies. Remember that any money you draw from your pension will form part of your estate for IHT purposes.
- Consider strategic gifting. Be sure to make full use of your annual gift allowances, small gift exemptions, or potentially exempt transfers (PETs) as a way of reducing the value of your taxable estate. For PETs to remain tax-free, you must survive for seven years after giving the gift.
- Explore trust options. While the new rules target pension funds, placing other assets into a trust could still help you mitigate IHT. You could also consider placing a whole-of-life insurance policy into trust as a way of helping your family.
- Review your will. Given these potential changes, ensure that your will is up to date and reflects your wishes.
- Speak to a financial planner. A qualified financial planner can assess your unique situation, calculate your potential tax liabilities, and help you develop a tailored and detailed estate plan that preserves your legacy as much as possible.
Keep in mind that enacting certain strategies, such as gifting or trusts, can be complicated. Even small mistakes can have lasting effects. Be sure to speak with a financial planner before taking any action.
Get in touch
Though these potential changes are not set to take effect until April 2027, the time to act is now.
Proactive planning, guided by financial advice, could be crucial in ensuring you’re able to pass down your wealth as effectively and tax-efficiently as possible.
This is something we can help with.
Email enquiries@metiswealth.co.uk or call 0345 450 5670 today to find out what we can do for you.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or will writing.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.