Pensions and Inheritance Tax: What Changes in April 2027 and What You Should Do Now
For many years, unused pension funds represented one of the most effective - and entirely legitimate - tools for passing wealth between generations. From April 2027, that changes fundamentally.
How Pensions Became an IHT Planning Tool
Since the pension freedoms of April 2015, unused defined contribution pension funds - SIPPs, personal pensions, and workplace DC schemes - have sat outside a person’s estate for Inheritance Tax purposes. This was not a loophole so much as an unintended consequence of how pension schemes are structured. In practice, it created a powerful planning opportunity. Wealthy individuals could draw on other assets during retirement while leaving their pension untouched, knowing the remainder could pass to children or grandchildren free of IHT. For many, pensions had become an inheritance tool as much as a retirement one.
What Is Changing
Chancellor Rachel Reeves announced the change at the Autumn Budget on 30 October 2024. Under the current legislation due to take effect on 6 April 2027, most unused pension funds and death benefits will be included within the value of an individual’s estate for IHT purposes. Transfers to a surviving spouse, civil partner, or registered charity remain exempt, as do death-in-service benefits. Everything else is in scope.
The Double Taxation Risk
For non-spouse beneficiaries, the impact can be significant. The pension pot is added to the estate and taxed at 40% above the available nil-rate bands. If the holder dies aged 75 or over, beneficiaries also pay Income Tax at their marginal rate on any withdrawals from the inherited fund. Whilst the legislation provides some relief to avoid full double taxation - Income Tax is not charged on the portion of the fund on which IHT has already been paid - the combined tax liability can still be significant, depending on the individual's circumstances.
What You Should Do Now
One area many individuals may wish to review is their Expression of Wishes - the nomination you lodge with your pension provider. Under the new regime, leaving pension funds to a spouse or civil partner may now be the more tax-efficient choice in many circumstances, even where the surviving spouse is financially independent. Where passing funds to children remains the right decision, careful thought should be given to how any IHT liability will be funded. For some individuals with substantial pension funds, it may be appropriate to consider whether increased drawdown could form part of their wider financial planning, although this will depend on individual circumstances.
The strategy of preserving a pension untouched as a tax-free inheritance vehicle no longer holds from April 2027. Plans built around the old regime need to be revisited.
Let’s Talk
It is therefore important to speak with your financial planner and to place a review of your Expression of Wishes on the agenda at your next meeting. If you have any questions, please do not hesitate to contact your adviser at Medical & General Independent Financial Advisers.
Disclaimer
This article is for information purposes only and does not constitute personal financial advice. Tax rules are complex and individual circumstances vary. Please seek professional advice before making any decisions.
