Upcoming changes to the tax treatment of pensions after death could have implications for your retirement income and legacy planning.
Although the changes will not come into force until April 2027, the effects on your financial plan could be significant. Because of that, you should be aware of what the new rules are and why you may need to review your plans now.
Some pension funds are currently exempt from Inheritance Tax
Up until now, many pension funds have sat outside your estate when calculating the value of your assets for Inheritance Tax (IHT) consideration.
As a result, pension funds are often an effective estate planning vehicle because they can help you shield a substantial sum from IHT and leave more to your beneficiaries. That said, there are exceptions to this and death benefits from certain pensions will form part of the estate, so it is important to seek professional advice to understand whether your pension will attract IHT.
This potential estate planning benefits of pensions were accentuated when the Lifetime Allowance, which limited the amount you could hold in your pension fund without incurring a tax charge, was abolished in 2024. This means you can accrue as much as you want in your fund, and it could remain exempt from IHT consideration.
However, the following changes (originally announced in the 2024 Budget) will remove that exemption.
Upcoming changes could result in your beneficiaries facing a double tax charge on your pension fund
From April 2027, if the total value of your estate, including pensions, exceeds your IHT nil-rate band (£325,000 in 2025/26 tax year) and your residence nil-rate band (£175,000 in 2025/26), your beneficiaries could pay 40% tax on the remaining portion. This change leaves more of your wealth vulnerable to IHT, particularly if you have a large pension pot.
Furthermore, if you pass away after you turn 75, they may face an additional tax charge as the amount they inherit could also be liable for Income Tax.
Looking at these rules in combination, from April 2027, pensions will no longer be such a tax-efficient way to pass wealth to your beneficiaries. If you had previously planned to use other assets to fund your retirement so you could pass on your pension tax-efficiently, your wider financial plans may need to change because of this new policy.
You may want to review your retirement income options
With your accrued pension fund potentially becoming liable for IHT, you may want to review the plans you have for providing yourself with an income in retirement.
Some options you may want to consider include:
- Prioritising drawing income from your pension fund rather than from other sources.
- Taking your tax-free lump sum, which for most people is 25% of your fund up to a maximum of £268,275 in total.
- Considering using some or all of your fund to purchase an annuity, which will provide you with a guaranteed income for the rest of your life, or for a fixed term.
In all three scenarios, you will reduce the value of your pension fund and the IHT liability that could arise from that.
However, we would strongly recommend you seek expert advice to assess the wider tax implications of each option on your long-term financial plan.
There are some straightforward steps you could take to reduce your Inheritance Tax liability
As well as adjusting your income planning, there are other options you may want to consider that could help reduce your potential IHT liability. These include:
- Taking out a life insurance policy, written into trust, that your beneficiaries may use to meet the cost of an IHT charge on your estate.
- Reducing the value of your estate over the years by utilising the annual exemption (a gifting allowance of up to £3,000 a year) or other exemptions (wedding gifts, regular gifts out of surplus income, small gifts of up to £250 per recipient).
- Making gifts above the gifting exemptions, while being aware of the seven-year rule that means the gift will only be entirely free of any IHT liability after seven years.
- Putting assets in trust, which essentially removes them from the value of your estate (after 7 years unless covered by an exemption). There may still be IHT to pay on assets in trust, but this is usually charged at a reduced rate.
How you go about reducing your liability will be dependent on your income planning and personal circumstances.
You should assess what the upcoming changes mean for you and ensure that your financial plans continue to meet your requirements.
Get in touch
If you would like to talk to us about your legacy planning arrangements and retirement income plans, please get in touch.
You can email enquiries@dbl-am.com or call 01625 529 499 to speak to us today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
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 tax planning, trusts or estate planning.
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.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.