What the Budget announcement about pensions and Inheritance Tax means for your estate
From April 2027, new Government rules will fundamentally change the way pension funds are taxed upon death.
For the first time, almost all unused pension funds will be included in an individual’s estate for Inheritance Tax (IHT) purposes, impacting defined benefit and defined contribution schemes alike.
What are the changes?
Currently, only non-discretionary pension schemes are generally subject to Inheritance Tax (IHT) on death, while discretionary schemes – which allow trustees some flexibility in distributing funds to beneficiaries – are usually exempt.
This exemption has made discretionary pension schemes an attractive option for many, as it allows significant wealth to pass down free of IHT.
However, beginning in April 2027, the Government plans to remove this exemption, meaning both discretionary and non-discretionary schemes will be treated consistently.
This means that, for the first time, most pension funds left unused at the time of death could be taxed at up to 40 per cent.
Only a few dependants’ pensions are expected to remain exempt, meaning that the majority of pension funds may be added to an estate’s IHT liability.
Who will be affected?
These changes have the potential to impact a wide range of individuals, particularly those with substantial pension savings or those who had planned to use discretionary schemes to pass on wealth tax-free.
High-net-worth individuals who were relying on pension funds as a key component of their estate planning strategy are especially likely to feel the effects, as large pension funds could now increase their IHT liabilities.
However, anyone with a pension plan should take these changes into consideration.
The inclusion of pensions in an estate for IHT purposes may affect the financial future of beneficiaries, possibly leading to larger-than-expected tax obligations.
How will this impact estate planning?
For those who have built their estate planning strategies around discretionary pension schemes, this change will likely mean that more proactive planning may be needed to protect assets intended for beneficiaries.
Early action will help adapt to the changes, even if they seem a little way off at present.
Options such as gift planning, setting up trusts, or making other tax-efficient arrangements may provide ways to lessen the impact.
Individuals may also want to revisit other aspects of their estate plans, such as lifetime gifting and alternative tax-efficient investment options, to ensure they are maximising the tax-efficiency of their estate.
What can you do now?
Reviewing your current pension arrangements and overall estate plan will provide insight into any adjustments that may be necessary. Here are some key steps to consider:
- Review your pension scheme – Understand the type of scheme you hold and the potential tax implications of the upcoming rule changes. Discretionary schemes may be particularly affected, but the changes will apply broadly.
- Evaluate your Inheritance Tax exposure – Calculate how your IHT liability may change once your pension funds are included and consider how this might impact the value of your estate left to loved ones.
- Explore other options for wealth transfer – Depending on your circumstances, alternatives like trusts or lifetime gifting may provide viable ways to reduce the size of your estate for IHT purposes.
- Consider early planning – Don’t wait until 2027 to adjust your estate planning. Acting now can give you more flexibility in mitigating the impact of the new rules.
While April 2027 may seem distance away, estate planning is best done proactively, and these changes mark a major shift in how pensions are treated for IHT purposes.
By taking action now, you can adapt your plans to help protect the financial future of your loved ones.
To discuss these changes and how they may impact your estate, please reach out to us for a consultation.