What are the Pension/Inheritance Tax changes coming into force in April 2027?

The Autumn Budget confirmed that from 6 April 2027, unused pension funds are to be included in an individual’s estate for Inheritance Tax (IHT) purposes. The government’s stated aim behind this is to bring back the principle that pensions are a source of retirement income, and not a vehicle for inheritance planning.

Certain exemptions will continue to apply. These will be for pensions left to a spouse or civil partner and dependent’s scheme pensions. These will continue to be taxed as income rather than being subject to IHT. Charitable donations from pension funds will continue to be exempt.

Like many, you may be interested in the options available to mitigate the impact of these new rules. As there are nearly two years before the rules take effect, you may wish to carefully consider your estate planning options. These include.

1.    Take pension withdrawals earlier than previously planned.

As the new rules do not affect withdrawals before death, you could consider drawing down your pension funds over time, using the tax-free lump sum and income withdrawals to reduce the size of your pension savings.

2.    Make gifts from withdrawn pension funds.

These gifts from pension withdrawals could be made to beneficiaries before death. This would reduce the size of your taxable estate. As these gifts are potentially exempt transfers (PETs) they would fall outside of IHT if you survive seven years. Alternatively, if you make gifts from your regular pension withdrawals, they may qualify as gifts out of income, which are immediately IHT-free.

3.    Review your pension beneficiaries.

Given that pension funds left to a spouse or civil partner remain IHT-free, you may want to ensure that you pass your pension to your spouse first, with assets passed to your children after that. Your spouse may then gradually draw down the pension fund and gift assets to the next generation of beneficiaries tax-efficiently.

4. Use pensions for charitable giving.

As stated already, pension funds left to a charity remain exempt from IHT. So, if 10% of an estate is donated to charity, the IHT rate on the remaining estate is reduced from 40% to 36%, providing additional tax savings.

5.    Consider alternative investment plans.

These changes may increase the relative attraction of ISAs. Whilst these may remain IHT-taxable, they are not subject to income tax on withdrawals. Other investment plans, such as investment bonds, may allow for greater control over tax-efficient withdrawals.

Conclusion

The removal of the IHT exemption for pension funds from April 2027 marks a major shift in how pensions are treated for inheritance planning. Furthermore, those who were preserving their pension to pass on tax-free should reconsider their strategy. For those failing to plan, or perhaps just unlucky, significant pension wealth could now face both IHT and income tax charges, leading to double taxation. Accordingly, careful pension and estate planning will be required to minimise the impact.

Actions to consider implementing:

•    Review your estate and pension strategy to assess the impact of the new rules.
•    Consider drawing down pension funds earlier and making tax-efficient gifts.
•    Ensure pension beneficiaries are structured efficiently, prioritising spousal transfers where possible.
•    Explore alternative savings options, such as ISAs and investment bonds.

Before proceeding

It’s important consider how this strategy aligns with your overall retirement goals and seek professional financial advice to explore the best options for your needs. Your Dentons Adviser can help you work out the right course of action for your personal circumstances.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.