How are pensions treated for Inheritance Tax?
Currently, pension benefits from registered pension schemes and lump sum payments on death are excluded from a person’s estate for IHT purposes. This means that, in most cases, the value of your pension pot will not be subject to IHT when you die. This principle was established by the Inheritance Tax Act 1984 and has been reinforced by subsequent reforms.
Major change from 6 April 2027
In the 2024 Autumn Budget, the government announced that from April 2027, any unused pension funds and certain death benefits will be included in the value of a deceased estate for the purposes of Inheritance Tax. The value of pension funds in excess of the available nil rate band of £325,000 will be liable to inheritance tax at 40% unless the fund passes to a spouse or civil partner.
The 2027 changes will apply to all overseas pension funds and not just UK registered pension schemes which will bring QNUP’s into the scope for IHT.
If it is your intention to draw down your pension to fund your lifestyle during retirement, then the inheritance tax change should not impact you. If, however, you have built up a large pension fund for the purposes of passing a larger proportion of your estate to your children inheritance tax free, you will now need to revisit and review your exiting inheritance tax planning strategy.
Action plan
- If your pension fund remains intact, consider taking the tax-free cash lump sum and either spend it or gift it to your children.
- Take a regular taxable income and making regular gifts out of surplus income.
- Consider the liquidity of your pension fund. Any IHT due on your death has to be paid within six months of death.
- If you are over 75 and you have not drawn down your pension fund advice should be sought to avoid the double taxation of inheritance tax and income tax for your beneficiaries.
- Review your death benefit nominations and leave pension funds to your spouse to benefit from the IHT spouse exemption.
- Take financial advice on using your pension fund to purchase an annuity.
In light of the 2027 changes, if you expect to have an unused pension fund on your death it is vital that you seek professional guidance to ensure your pension savings are passed on as efficiently as possible.
If you are affected by any of the above, please contact Kay Aylott at Kaylott@haysmac.com
