Major changes to the Inheritance Tax treatment of pensions are coming - and the impact of the changes could extend beyond the pension pot itself.
From 6th April 2027, most unused pension funds and pension death benefits will be included in a person's estate for Inheritance Tax (IHT) purposes.
For some families, the changes could result in a higher Inheritance Tax bill. This is because previously excluded pension savings will count towards the total value of the estate.
There could also be an additional impact for larger estates. If including pension savings takes the value of an estate above £2 million, it may start to reduce the Residence Nil-Rate Band. This is an additional Inheritance Tax allowance that may be available when a qualifying home is passed to children or other direct descendants.
With the new rules approaching, now is a good time to review your Will, pension arrangements and wider estate planning.
What is changing with pensions and inheritance tax?
At the moment, many pension funds can sit outside a person's estate for IHT purposes.
This has made pensions an important consideration in estate planning, with some people choosing to use other savings during retirement and leave their pension funds untouched for their beneficiaries.
But from 6th April 2027, this position will change. Most unused pension funds and pension death benefits will be brought into the deceased person's estate when calculating IHT.
There will be some exceptions, including death-in-service benefits payable from registered pension schemes.
Could your pension affect the residence Nil-Rate Band?
This is an important potential consequence of the new rules.
The standard Nil-Rate Band - the amount of an estate that can generally be passed on before Inheritance Tax becomes payable - is currently £325,000.
There is also a Residence Nil-Rate Band of up to £175,000. This additional allowance may be available when a qualifying home is passed to direct descendants, such as children or grandchildren, subject to the relevant conditions.
However, the Residence Nil-Rate Band begins to reduce when the net value of an estate exceeds £2 million. For every £2 by which the estate exceeds the £2 million threshold, £1 of Residence Nil-Rate Band is lost.
Adding previously excluded pension wealth to an estate could therefore have two consequences. Firstly, it could increase the overall value of the estate for IHT purposes. Secondly, for estates around or above £2 million, it could reduce - or potentially eliminate - the Residence Nil-Rate Band.
For example, someone whose other assets are already approaching the £2 million threshold could find that the inclusion of a substantial unused pension changes their IHT position significantly.
How many families could be affected?
Most estates will still have no IHT liability following the changes.
However, HMRC estimates that in 2027/28 approximately 10,500 estates with inheritable pension wealth will become liable for IHT when they would not previously have been, while around 38,500 estates will pay more IHT.*
HMRC estimates the average increase in IHT liability for affected estates at around £34,000, although individual circumstances will vary considerably.
Should you change how you use your pension?
Not necessarily.
The forthcoming changes do not mean that everyone should start withdrawing money from their pension or giving assets away.
Pensions remain primarily designed to provide an income during retirement, and decisions about withdrawals can have wider tax and financial consequences.
Similarly, gifting assets during your lifetime can form part of estate planning, but there are rules around gifts and IHT that need to be considered.
The important point is that estate-planning strategies developed under the existing pension rules may no longer produce the same outcome after April 2027.
Time to review your estate planning?
If you have significant pension savings, property and investments, it is sensible to understand how the changes could affect your overall estate.
This could include reviewing:
- the current value of your pension funds
- your property and other assets
- your existing Will
- who you want to inherit your estate
- your potential entitlement to the Residence Nil-Rate Band
- any lifetime gifts or trusts
- your plans for drawing pension income during retirement.
Legal advice should be considered alongside appropriate independent financial and tax advice before making significant changes.
The changes will also affect executors
The reforms could also make administering some estates more complicated.
Personal representatives will be responsible for reporting and paying IHT attributable to pension funds included within the estate.
This means executors may need to identify pension arrangements, obtain valuations and liaise with pension providers before the estate's overall IHT position can be established.
Keeping clear records of your pensions and other assets can therefore make matters considerably easier for those administering your estate.
How Coles Miller can help
Inheritance Tax and estate planning can be complicated, particularly when pensions, property, investments and family circumstances all need to be considered together.
Coles Miller's experienced Wills & Probate team can help you review your Will and wider estate-planning arrangements, in light of the forthcoming pension changes.
We can advise on Wills, trusts, lifetime gifting and estate planning, as well as probate, Inheritance Tax and the administration of estates.
The key is to plan ahead. With the pension changes taking effect from 6th April 2027, reviewing your arrangements now gives you time to understand how the new rules could affect your family and whether any changes may be appropriate.
If you are concerned about how the new pension and Inheritance Tax rules could affect your estate, contact Coles Miller's Wills & Probate team for advice.
