As mentioned in a previous blog piece, Labour’s Rachel Reeves’ Autumn 2024 Budget statement announced plans to include unused pensions and certain death benefits in the value of a person’s estate, effective from April 6 2027, for the purposes of inheritance tax. Whilst pensions currently play a considerable role in strategic estate planning, many people have questions about the future of their pensions and their later-life financial planning. We have therefore put together a little bit more information on what this means.
Quick summary
• From April 6, 2027, the government will include unused pension funds and death benefits within the value of a person’s estate for inheritance tax purposes.
• Lump sum death benefits, even with recipients chosen at the discretion of a trustee, will also become part of a person’s estate and become liable for IHT.
• It will be the responsibility of Pension Scheme Administrators (PSAs) to report and pay any IHT due from unused pensions and death benefits funds.
• Dependants’ scheme pensions will be exempt from IHT. Some lump sums paid to charities will also be exempt.
• The inheritance tax nil-rate band remains locked at £325,000 following a prior extension to 2028.
How it currently works
As of the current year, 2025, inheritance tax doesn’t usually apply when you pass on your pension pot. This is because your pension doesn’t normally contribute to your taxable estate.
This means that pensions have been a tax-efficient way to save and invest with the intention of passing down your cash to future generations. There are also tax benefits on future investments involved with pensions.
Most pensions include provisions called ‘death benefits’, that take effect when you die. This may include giving your family the rest of the money that is in your pension pot. As it stands, these are usually not liable for inheritance tax, and do not count towards your estate.
Death benefits allow you to pass on your pension savings to your beneficiaries. This can be free of income tax if you die before age 75 and you either: -
a) leave a lump sum death benefit that is less than your remaining Lump Sum Death Benefit Allowance (£1,073,100; anything over this will be taxed at the recipient’s marginal rate of income tax); or
b) leave the pension as beneficiary drawdown/annuity.
At age 75 and beyond, your beneficiaries are subject to pay income tax at their own tax rate for the money they take out of your pension plan, whether lump sum, annuity, or drawdown.
Most lump sum death benefits (LSDB) are also exempt from IHT, as the pension scheme trustees have some discretion over who receives the benefits. If the pension trustees do not have any discretion over who the beneficiaries are, then the pension death benefits will form part of the estate for IHT purposes. (It is worth noting that not all pension schemes have death benefits).
The upcoming changes to pensions and inheritance tax April 2027
As of April 6, 2027, most unused pension pots and death benefits will form part of your estate, and will be liable to inheritance tax charges. Chancellor Rachel Reeves has outlined the changes we can expect to see regarding pensions and inheritance tax.
Authorised death benefits will form part of your estate, including both defined contribution (DC) and defined benefits (DB) schemes, and lump sums to recipients chosen at a trustees’ discretion. If your estate then exceeds the IHT threshold, any excess – including your unused pension pots – will be subject to a 40% tax rate.
Pension death benefits paid to a spouse or civil partner will remain exempt from IHT, as long as they are UK domiciled. Dependants’ scheme pensions and charity lump sum death benefits will also be exempt. Otherwise, pension death benefits will be included for IHT.
It will be the responsibility of your Pension Scheme Administrators (PSAs) to report, calculate, and pay death benefit payments to HMRC, and to pay any inheritance tax due from those benefits. Your trustees will be required to liaise with your executors or administrators to determine the tax payable.
These changes will apply regardless of whether your pension scheme is UK registered, or a qualifying non-UK scheme.
What are the implications?
Beneficiaries could now be liable for both income tax and inheritance tax on inherited pensions. If you die after the age of 75, your beneficiaries could face up to 67% tax on your inherited pensions.
Current estate planning that includes significant focus on pension plans may need reviewing. Pensions as a tax-efficient strategy may lose appeal, and other wealth management strategies may need implementing.
Executors, administrators, and trustees will have an obligation to liaise with one another to determine the inheritance tax payable on your estate.
It’s currently a common strategy among retirees to preserve the majority of their wealth within their pensions, opting to utilise other assets like ISAs or savings first to maximise the amount they can pass on tax-free. However, with the forthcoming changes, this approach will likely shift, making a decumulation strategy a potentially more tax-efficient alternative.
Commenting on the changes, Senior Paraplanner at Almond Financial, Ryan Sharpe said:
‘The biggest change is that pensions will no longer be a default option, capable of meeting most people’s retirement and inheritance tax-planning needs simultaneously. Careful consideration of each person’s circumstances will be more necessary than ever before to identify the best strategies.’
Exemptions from inheritance tax
Most dependants’ scheme pensions will be exempt from any inheritance tax charges, whether from a defined benefit or a defined contribution scheme.
Any estates, including unused pensions and death benefits, that remain below the value of the current nil-rate band of £325,000 will be exempt from inheritance tax. £175,000 residence nil-rate band is also available where homeowners leave a property to direct descendants.
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