Autumn Budget: Pensions subject to inheritance tax

The Government plans to include pensions in estates for inheritance tax (IHT) from April 2027. This change is controversial and could significantly increase the tax burden on many estates, especially affecting unmarried couples. 

 What does this mean? 

The Government claims this will affect around 8% of estates each year, however, the changes  will impact  a broad range of savers and disadvantage  couples who are unmarried or not in a civil partnership. 

Take Joe – he has saved hard to build his pension pot to £1,073,100 (the former lifetime allowance). With other savings of around £288,000 and a property of £989,000, his current estate would suffer an inheritance tax liability of £310,760, or around 13% of his wealth.  

From April 2027, Joe’s pension will fall within his estate, meaning his estate will be greater than the residence nil rate band. The impact will be an IHT liability of £810,000, or around 35% of his wealth. This increase in IHT represents 47% of Joe’s pension savings. 

Even for married couples (and those in civil partnerships), this will be painful. If Joe were married to Jane, who has a pension pot of £350,000, their current position would shift dramatically from an IHT liability of £110,760 to £820,000 – around 30% of their wealth. The increase in IHT represents around 50% of their pension savings. 

 Are there remedies?  

The twist in the Budget announcement for pensions is, having set alarm bells ringing that tax-free cash would be further curtailed, this increasingly valuable allowance has survived intact. If Joe and Jane withdraw their tax-free cash lump sums and gift them, they might well restore the residence nil rate band and so reduce IHT on their pension savings from 50% to a more respectable 35%. 

Where the pension fund passes to a surviving spouse or civil partner, the spouse will still inherit the fund free of inheritance tax. However, unlike other assets, withdrawing from pensions, say to gift, subjects the individual to income tax.  

The old mantra that pensions are ‘first in and last out’ when it comes to drawing on wealth in retirement might now itself be retired. Instead, lifetime pension planning will be important, and particular care should be taken to review pension wishes on death to avoid even further tax.   

 What’s next? 

As part of these changes, pension scheme administrators will become liable for reporting and paying any inheritance tax due on unused pension funds and death benefits. 

 There is no detail around the implementation and instead the industry is invited to respond to a consultation that will run until 22 January 2025. Following this review, we can expect more detail and draft legislation in due course. 

It would be wise to take professional advice on how you might craft an efficient plan.