Pensions have always played a big part in estate and Inheritance Tax (IHT) planning. For many, leaving behind a pension pot has been a clever way to pass on wealth efficiently. But the landscape is about to change. The 2024 UK Budget announced that, from April 2027, unused pension funds will be brought into the IHT net, a move that could change how we structure and pass on our estates.
What are the current rules?
At the moment, if someone dies with a pension pot they haven’t used, the treatment of that fund depends on their age at death. If they die before 75, the pension can be passed on entirely tax-free to a nominated beneficiary. If they die aged 75 or more, the recipient pays Income Tax on the amount received at their marginal rate.
Crucially, under the current regime, pension funds aren’t included in the deceased’s estate for IHT purposes. Most pensions are held in trust and controlled by scheme trustees or administrators rather than being part of the individual’s assets. This has allowed pension pots to be a valuable tool for reducing the overall IHT burden, especially for those who can live off other sources of income.
What’s changing from April 2027?
From April 2027, unused pension funds will be treated very differently. Under the proposed changes, any remaining pension fund at death will be included in the deceased’s estate for IHT purposes. Therefore, if the total estate, including the pension, exceeds the IHT threshold, tax will be due.
The responsibility for this will fall to pension scheme administrators who will have to report and pay the IHT before distributing the funds. The details are still to be finalised, but the direction of travel is clear.
And it doesn’t stop there. If the pension holder dies aged 75 or older, the beneficiary may still have to pay Income Tax on top of the IHT liability, potentially resulting in a significant overall tax bill.
Estate Planning Implications
These changes could have significant implications for anyone using their pension fund as a tax-efficient means of passing on wealth. While transfers between spouses and civil partners are exempt from IHT, relying solely on this approach could mean a bigger IHT bill when the surviving spouse dies.
So, what’s next? Some may now rethink how they use their pensions. Instead of preserving pension savings, they may choose to draw them down more actively, whether through income drawdown or an annuity, and pass on other assets through gifts and available exemptions during their lifetime.
Why advice is more important than ever
The changes ahead highlight the need to review your estate planning. Every family is unique, and what worked in the past may not be the best option now. We always recommend taking professional financial advice before making any substantial decisions.
At Morgans, our experienced team will work alongside your financial adviser and help you through these changes. It is essential to ensure your arrangements continue to work for you. Whether you’re just starting your estate planning journey or reviewing an existing plan, we’re here to help.
Get in touch with Morgans private client solicitors in Dunfermline or Kinross for tailored advice on Inheritance Tax and estate planning.
