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What do the new changes to inheritance tax mean for your pension?

14th May, 2025

Published in The Business Eye in March 2025. 

In the Autumn Budget on October 30, 2024, Rachel Reeves announced several measures to reform inheritance tax, including bringing most unused pension funds within the value of a person’s estate for Inheritance Tax (IHT) purposes from April 6, 2027.

The Government explained that, in its view, pensions are increasingly used as a tax planning tool rather than for retirement funding. For most individuals who will be relying on their pension to provide them and their spouse with an income upon retirement, the introduction of an IHT charge on death is unlikely to dramatically affect their plans. However, for individuals who do not require an income from their pension funds and have intended to pass them to future generations, it is a very different story.

Previous and current legislation (pre-April 2027):

Before 2011, most individuals had to use their defined contribution pension fund to purchase an annuity at age 75, which could not be passed onto children. Before April 2015, funds that had not yet been used to provide retirement benefits could be passed tax-free if the individual died before 75, but funds already being used to provide benefits faced a 55% tax charge. Individuals could continue in taking an income beyond age 75 if they had sufficient ‘secure income’, however upon death after 75 an effective tax charge of 82% would occur.

Post-2015, pensions became very tax efficient. Until the new changes take effect, individuals with defined contribution plans who die before 75 can pass their pension funds to beneficiaries free of both income and inheritance tax. However, on death after 75, any funds taken out of the pension tax wrapper will be subject to income tax at the beneficiaries’ marginal rate.

Proposed changes (post-April 2027):

From April 6, 2027, it is proposed that pension funds will be included in the estate value for IHT. Exceptions include dependants’ scheme pensions and charity lump sum death benefits. Transfers to a spouse or civil partner will be IHT-exempt but IHT will apply when passing to others (e.g., children, grandchildren).

Executors will work with pension administrators to confirm fund values and use an HMRC calculator to apportion the available nil-rate band between pension and nonpension assets. The scheme will then pay the IHT directly to HMRC before paying beneficiaries.

Potential effects:

For those affected by the changes, the tax payable on pension funds could be significant. The current nilrate band allows £325,000 to be passed tax-free, with a 40% IHT charge on amounts above this. The Residence Nil Rate Band (RNRB) provides an additional £175,000 if the family home is inherited by direct descendants. Estates over £2m may lose the RNRB, leading to higher effective IHT rates once pensions are included. Income tax also applies if the individual dies after age 75.

Potential actions to consider:

Review your ‘expression of wish’ forms and ensure they are written with the flexibility to allow trustees to pass funds directly to your children should you die before the 2027 changes, should your surviving spouse not require them.

It will become more attractive to spend your pension funds before other assets. You could also consider insuring against IHT liability, withdrawing tax-free cash, making regular gifts out of income, or donating pension funds to charity.

The imposition of IHT on pensions should not be seen as a barrier to those still saving into their pension which remain the most tax efficient option for most people. However, the proposals mark a significant change in retirement and inheritance planning and it’s important to review your financial plan considering your personal circumstances and objectives. Speak to your advisor should you have queries or wish to discuss how these changes impact you.
 

If you would like to discuss anything covered in this article, please contact Susan McNickle or your Davy UK Wealth Manager.