The upcoming changes to inheritance tax (IHT) rules on pensions in April 2027 will significantly impact how pensions are treated when passed on after death. Accordingly, we are pleased to identify some of the key issues to start considering so as to plan ahead:
Current Rules on Pensions and IHT
- Pensions held in defined contribution schemes (eg. SIPPs) are generally outside your estate for IHT purposes, provided they remain in the pension wrapper.
- Beneficiaries may inherit pensions free of income tax if the pension holder died before age 75. After age 75, withdrawals by beneficiaries are taxed at their marginal rate of income tax.
Changes from April 2027
The government announced in the Budget in October 2024 plans to introduce reforms targeting the IHT treatment of pensions, though details are subject to a consultation. It is expected that the reforms may result in the following changes:
- Pension funds may be included in the taxable estate for IHT purposes, which would particularly impact larger estates and/or larger pension funds.
- Tax relief on inherited pensions might be reduced to mitigate tax avoidance through “deathbed contributions.”
- Potential limits could be imposed on how much can pass to beneficiaries without IHT.
These changes are intended to reduce the perceived imbalance between pension wealth and other assets when calculating IHT liabilities, as well as increase the overall tax take by the government from IHT.
Planning Strategies
To prepare for potential changes in 2027, strategies such as those listed below may be appropriate (we will provide formal bespoke advice to clients where appropriate):
1. Maximise Pension Contributions Before 2027:
- Contributions up to the annual allowance (maximum of £60,000 in 2024/25, when supported by relevant earnings) offer significant tax advantages and keep funds outside your estate for now. This may be appropriate for smaller estates.
• Use carry-forward allowances to boost contributions further before reforms take effect.
2. Nominate Beneficiaries for Pension Death Benefits:
- Ensure your Expression of Wish form for your pension is up to date, as trustees consider this when deciding who receives your pension.
- Designate beneficiaries strategically, considering their tax positions and potential future IHT liabilities.
3. Draw Down Pension Funds Gradually
- If pensions become taxable for IHT, drawing down funds and transferring them into IHT-efficient vehicles, such as trusts, may be beneficial, subject to careful consideration of income tax on pension drawings.
• Evaluate lifetime gifting strategies, which are tax-efficient if you survive 7 years after making the gift.
4. Use Trusts for Estate Planning:
• For larger estates, consider trusts to shelter assets from IHT. Trusts can hold investments or cash while enabling control over how the funds are used.
- Transfers to a spouse are exempt from IHT, so this is a valuable exemption which should be used.
5. Review Non-Pension Assets:
- Balance your retirement income sources by considering withdrawals from ISAs, other investments, or property income to complement pensions. This may help to mitigate income tax.
- Work out the best combination from a tax perspective in respect of the sources for retirement income taking account both income tax and IHT.
6. Consult Seabrook Clark:
• We are pleased to provide clients with a detailed review of their circumstances so as to ensure pension and estate plans remain efficient under changing rules.
• Revisit plans annually, especially as new announcements clarify the details of the 2027 reforms.
7. Prepare for Policy Updates:
• Stay informed about government updates on IHT and pensions to adapt your strategy as required.
- For most clients, it is best to defer any action for the time being since the consultation should clarify how IHT will be implemented from April 2027. There is significant uncertainty at present in respect of the pension IHT reforms. For the next 27 months pensions remain free of IHT, so we advise monitoring the situation for now in preparation for acting as necessary over the coming year.
Please note that the content on this page is based on our understanding and the available information; we cannot be held responsible for any errors, and you should not act on the basis of the information in these articles, nor do they constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch via telephone at 01392 875500 or email at info@SeabrookClark.co.uk.