Previously, pensions have been an effective way to leave a tax-efficient legacy, ensuring your beneficiaries get the most from the funds you’ve saved throughout your working life. But that may be set to change if and when new rules are implemented.
The Labour government’s recent Autumn Budget on 30 October included significant reforms to pensions and Inheritance Tax (IHT), with some aspects still under review.
Under the current rules, if you die before age 75, your pension pot can normally be passed on tax-free to your beneficiaries as income. If you die after 75, the pension is usually taxed at your beneficiary’s marginal Income Tax rate.
As a result, many pension savers have delayed drawing from their pension funds, choosing instead to use other assets for retirement spending.
The government has expressed its intent to maintain tax incentives for pension savings, such as tax relief on contributions. However, it is considering changes to bring pensions into estates for IHT purposes.
This move aims to encourage people to use their pension savings during retirement, rather than preserving them as an efficient inheritance strategy.
Read on to learn how the proposed changes to pensions and IHT might affect you.
Pensions may be liable for Inheritance Tax from 2027
Chancellor Rachel Reeves announced plans to include unused pensions and certain pension death benefits in the value of estates for IHT purposes starting in April 2027.
This change will only affect estates that exceed the nil-rate band – the threshold below which no IHT is due. However, Reeves also confirmed that the nil-rate band (£325,000 in 2024/25) will now remain frozen until 2030, two years longer than previously planned. Indeed, the value of many pensions alone often exceeds the threshold, even before accounting for any other assets.
The precise details of how IHT on pensions will be applied are still under review, and until April 2027, you can still pass your pension to your beneficiaries without incurring IHT.
Given this evolving situation, it’s wise to avoid rushing decisions regarding your retirement savings before more concrete rules are confirmed.
There are still exemptions that could help limit the Inheritance Tax liability of your pension
Although the nil-rate band will remain frozen at £325,000 until 2030, other IHT exemptions continue to apply.
This includes the spousal exemption, which means that anything you leave to your spouse or civil partner – including pensions – is entirely exempt from IHT.
Pensions you leave to other beneficiaries will only be subject to IHT if your total estate exceeds the available nil-rate band and other allowances.
You can also benefit from an additional £175,000 residence nil-rate band if you leave your main residence to your direct descendants – children, grandchildren, stepchildren, and so on. However, this extra allowance begins to taper if your estate is valued at over £2 million.
So, if you’re married or in a civil partnership, your combined allowances generally allow you to pass on up to £1 million tax-free when one of you dies, provided they leave their estate to the surviving partner.
Beyond these thresholds and allowances, the standard IHT rate is 40%. However, even if your estate falls below the nil-rate band, your beneficiaries may still need to pay Income Tax on their pension withdrawals, though this is yet to be confirmed.
It’s a good idea to keep your pension and estate plan under review
With the reforms currently being reviewed and not set to be introduced until 2027, it may be wise to hold off on making any immediate changes in response to the recent announcements, as further details are likely to emerge.
In the meantime, you might want to consider exploring alternative strategies for efficiently passing on your savings and legacy to your beneficiaries. By planning ahead, you’ll be better prepared to take action if and when the reforms are implemented.
Giving gifts remains an efficient way of reducing your estate’s liability
Giving gifts can be an effective strategy for reducing your estate’s IHT liability.
For the 2024/25 tax year, you have an “annual exemption” that permits you to gift up to £3,000 a year without it being added to the value of your estate.
If you don’t use the full annual exemption in one tax year, you can carry over any unused portion to the following year.
Gifts exceeding the annual exemption are considered potentially exempt transfers (PETs). If you pass away within seven years of making a PET, IHT may apply, but at a reduced rate, depending on how long you survived – this is known as “taper relief”.
If you survive for seven years, the gift is generally exempt from IHT. Bear in mind that PETs will be the first part of your estate to be calculated against your nil-rate band. So, if your PETs do not exceed the nil-rate band, your loved ones won’t benefit from a tapered rate of IHT.
By gifting during your lifetime, you can reduce the value of your estate and potentially lower the IHT burden on your beneficiaries.
Assets held in trust are usually not considered part of your estate
Transferring assets into a trust can effectively remove them from your estate for IHT purposes, as long as certain conditions are met.
However, the rules around trusts and IHT can be complex and there are management costs and other tax implications involved.
So, while placing assets in trust can help reduce your IHT liability, it’s a good idea to consult with a financial planner before proceeding, especially as once you’ve transferred your assets into a trust, it is irrevocable.
A financial planner can guide you in selecting the most appropriate trust for your objectives, ensuring the strategy aligns with your estate planning goals and benefits your beneficiaries.
Get in touch
Our team of independent financial advisers in Lewes is here to support you in creating a tax-efficient estate plan, aligned with any legislative changes, that helps ensure your beneficiaries are supported after you’re gone.
To find out more, please get in touch by emailing us at financial@barwells-wealth.co.uk or by phone on 01273 086 311.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, cashflow planning, tax planning, trusts, Lasting Powers of Attorney, or will writing.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
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