As announced in the 2024 Autumn Budget, pension savings will be brought into the Inheritance Tax (IHT) net from 6 April 2027. As we approach this deadline, it is important to consider the impact these far-reaching changes may have on your estate’s IHT liabilities.

Under the current rules, for a death before 75 years old, there is no tax payable on pension funds, as they are outside the scope of IHT, and no income tax is payable by the beneficiaries when they draw on the pension. However, on a death after 75, the death benefits drawn are subject to income tax at the recipient’s marginal rate.

From 6 April 2027, any unused pension funds will form part of the estate for IHT purposes, with IHT chargeable at 40%. The income tax position of the beneficiaries is unchanged; therefore, where the recipient pays income tax at the additional rate on the death benefits, an effective tax rate of 67% can apply to these funds.

In some cases, this may also impact the availability of the Residence Nil Rate Band (RNRB) of £175,000. Prior to the changes, pension funds were not included when assessing whether the RNRB should tapered, but from 2027 they will be taken into account.

Below, we’ve put together some case studies examples to show the implications this may have.

Case study 1:

Firstly, consider an individual with no children and assets valued at £750,000, together with pension savings of £500,000. They will not be entitled to the RNRB, as they have no direct descendants to whom their home can be left. If the death occurs before 6 April 2027, the IHT payable, after applying the NRB (which all individuals are entitled to), would be as follows:

If they were to die on or after 6 April 2027, the IHT liability would be increased as follows:

The IHT bill therefore more than doubles, increasing by £200,000 to £370,000. This increase arises solely from the IHT charged on the pension savings.

Case study 2:

Next, consider a widowed individual, with two children. They have assets worth £2,000,000 and pension savings of £700,000. All assets pass to their two children on death. Before the changes, the individual would benefit from the full RNRB, including the unused RNRB of their deceased spouse. They would also benefit from the unused nil rate band (NRB) of their deceased spouse in addition. [LS1] [RP2] In the event of death before 6 April 2027, the IHT payable on the estate would be as follows:

If they were to die on or after 6 April 2027, the IHT liability would increase as follows:

The IHT payable more than doubles in this case, too. Not only do the pension savings come into charge, accounting for £280,000 of the £420,000 increase - but the RNRBs are also fully withdrawn, adding a further £140,000 to the IHT due.

As covered in this article, previous advice centred around using pension savings last, while they remained outside the scope of IHT, but this will no longer be the case from April 2027. It may now be worth considering drawing on the funds sooner, and how these may be used as part of a lifetime gifting strategy.

It is important to remember that the age at which an individual may begin accessing the funds in private pension pots will increase to 57 with effect from April 2028, making planning around these changes more difficult to navigate until they reach that age. To date, no changes have been suggested to the flexi-access drawdown rules introduced in 2015, so planning around pension savings may still be considered once the access age has been reached. In the meantime, individuals under 55 (57 from April 2028) will need to consider other liquid assets for lifetime planning. This may become a factor in the investment decision-making process.

How we can help

As illustrated in the case studies, these rule changes can have a significant impact on your IHT exposure, particularly where there is also a potential impact on the availability of the RNRB.

While we appear to remain in a period of frequent changes to IHT, and indeed wider to tax rules, we recommend keeping advice up to date based on existing legislation and announcements, while also keeping an eye on developments.

We would welcome the opportunity to discuss your estate planning options and advise on which of these may suit your specific circumstances and goals. No two individuals have the same circumstances, so tailored, individual advice is always recommended.

We would also be happy to work with your financial planner, or our own financial planning team, to provide joined up tax and financial planning advice on your pensions and wider investment decisions.