Transforming Inheritance: Including Pensions in Estates for IHT from April 2027

In her latest budget, Chancellor Rachel Reeves introduced a major change to inheritance tax rules, bringing pensions into the scope of an individual’s estate.

Previously exempt from inheritance tax, pensions will now be included when calculating the total value of an estate, potentially increasing tax liabilities for beneficiaries.

BACKGROUND

Inheritance Tax (IHT) only begins to apply when an estate reaches a certain size. Your estate can include any money held in cash or investments, property and other possessions.

Up to £325,000 can be passed on with no IHT due. This is known as the “nil-rate band”. Anything over the nil-rate band can potentially face 40% tax, but there are several exemptions that can be used before the tax is due.

Currently, pension death benefits are typically free of IHT – regardless of whichever way the benefits are taken. However, this is set to change. As announced in the Autumn Budget 2024, most pension death benefits will be included in the member’s estate for IHT purposes from 6 April 2027.

Where a Client dies after 6 April 2027, most death benefits will be included within their estate for IHT. The consultation paper confirms this will apply to the below.

WHAT WILL BE CAUGHT?

• All residual Defined Contribution funds, whether in drawdown or uncrystallised
• Defined Benefit lump sum death benefits
• Annuities – where there are survivors’ death benefits
• Lump sums from pensions in payment with value protection
• Trivial commutation lump sum death benefits
• The above benefits will be included with the estate regardless of whether the scheme administrators/trustees have discretion over the payment of death benefits or not

EXCEPTIONS

• Dependants’ scheme pensions
• Charity lump sum death benefits
• Where benefits are paid to a spouse or civil partner these will be covered by the spousal exemption

TAXING PENSION BENEFITS

The value of the pension death benefits paid to a non-spouse or civil partner will be aggregated with the other assets in the deceased’s estate. It will be down to the pension scheme to deduct and pay any IHT which may be due on pension death benefits. But, before this can be done, the scheme administrator will need to know how much of the deceased’s available IHT nil rate band is to be deducted.

Obtaining the necessary information to apportion the nil rate band may well lead to delays in obtaining probate and distributing both the estate and any pension death benefits. Any IHT due, by both the estate and any pension schemes, must be paid within 6 months from the end of the month in which death occurred to avoid late payments fees and interest.

HIGH RATES OF TAX

Where death occurs after age 75, both IHT and income tax may be payable. For example, where IHT is due, £100 of pension money would be subject to 40% IHT, leaving £60. If death occurs after age 75, this money would then be subject to the beneficiary’s rate of Income Tax. In the worst case, this would be 45%, resulting in just £33 being received by the beneficiary – an effective tax rate of 67% (or 52% where income is taxable at basic rate).

ACTIONS TO CONSIDER

• Review your IHT position
• Review the types of pensions you have
• You may need to reorganise your savings and alter your sources of retirement income to remain tax-efficient
• There is a strong argument for consolidating pension schemes for those with multiple pension pots to avoid repeated information requests and reduce the risk of delaying the distribution of the estate
• You can give regular amounts away that you don’t need from your income without IHT applying. That means your salary, rents from property, investment and savings income after tax, but not capital itself

This shift in policy is expected to impact thousands of estates each year, making it more important than ever for Clients to reassess their financial and estate planning strategies. If you would like to discuss how these changes may impact your future financial plans, please contact your Finura Financial Planner here.

Articles on this website are offered only for general information and educational purposes. They are not offered as, and do not constitute, financial advice. You should not act or rely on any information contained in this website without first seeking advice from a professional.

Past performance is not a guide to future performance and may not be repeated. Capital is at risk; investments and the income from them can fall as well as rise.

You are now departing from the regulatory site of Finura. Finura is not responsible for the accuracy of the information contained within the linked site.

Date written: 10^th February 2025 by Gavin Murphy, Chartered & Certified Paraplanner.

Approved by Evolution Wealth Network Ltd on 20/02/2025.