What you need to know

Since 2015 pensions have been an efficient tool for passing on wealth tax-efficiently to the next generation. The October 2024, Budget introduced major changes to pension inheritance tax (IHT) rules, requiring individuals to rethink their estate planning strategies.

From 6th April 2027, unused pension funds and death benefits will be included in IHT-assessable estates. Pension administrators will report and pay IHT directly to HMRC, increasing the number of estates subject to IHT.

So, what do the new rules mean and should you consider taking immediate action?

• Dual Taxation for Over-75s: Pension death benefits could face both IHT on death of the member and Income Tax when beneficiaries withdraw funds.
• Under-75 Lump Sums: Death benefits exceeding the Lump Sum Death Benefits Allowance (LSDBA) will also face dual taxation.
• Spousal Exemption: Transfers to a surviving spouse or civil partner remain IHT-free, but the inherited funds will be included in the survivor’s taxable estate.

Key Strategies for Pension Savers

Individuals with significant pensions need new approaches to minimise IHT exposure:

• Review Contributions: Limiting or stopping contributions can help avoid excessive accumulation.
• Use Tax-Free Lump Sums: Withdraw 25% tax-free and gift it into a Flexible Reversionary Interest Trust, which becomes IHT-free after seven years.
• Gifts from Income: Use pension income to fund regular gifts into Trusts, benefiting from immediate IHT exemption under the “Gifts from Normal Expenditure” rule.

High-Value Estates and RNRB

For estates exceeding £2 million, including pensions in taxable estates could significantly reduce the Residential Nil Rate Band (RNRB) due to tapering rules. This could lead to compounded IHT burdens, underscoring the need for proactive planning.

Where the Pension has full tapered away the RNRB* we find that the total percentage of the pension fund deducted from the overall estate could be 72% for basic-rate taxpayers, 84% for higher-rate payers and 87% for additional-rate payers.

*£2,350,000 for a single person’s estate or £2,700,000 upon the second death of a couple where the RNRB of the first to die has been transferred to that estate.

Trusts as a Solution

Flexible Reversionary Trusts offer dual benefits: tax efficiency and wealth protection. Gifts into these Trusts are Lifetime Chargeable Transfers for capital and exempt transfers for surplus income.

Act Now

The 2027 changes demand immediate planning. Lifetime gifting and Trusts are critical tools to mitigate IHT, reduce tax burdens, and protect family wealth across generations.