Following the Autumn Budget, from April 2027, pensions will be included in your estate for inheritance tax (IHT) purposes. While this won’t affect most retirees who rely on their pension for income, it will impact wealthier individuals who intended to pass their pension to the next generation tax-free.
Individuals will need to adapt, but there are ways to mitigate the impact. Here’s what you need to know.
Who Will Be Affected?
If you are using your pension for retirement income, these changes are unlikely to make a big difference to you. The spousal exemption will remain, meaning there is no IHT to pay when passing pension benefits to a surviving spouse or civil partner. However, if you were planning to leave your pension to children or other beneficiaries, you may face a higher IHT bill.
What Can Be Done?
While this change alters the way pensions are treated, core IHT planning strategies remain the same. These include:
- Insuring against the IHT liability
- Gifting assets to reduce the value of your estate
- Using exemptions and reliefs effectively
Pensions will now be treated like other assets for IHT, but they still have tax advantages. Unlike other investments, pension funds grow tax-free and are protected from income tax and capital gains tax (CGT).
A Holistic Approach to Gifting
If you want to reduce your estate’s IHT exposure, gifting assets is a common strategy. However, deciding which assets to gift should be considered carefully:
- Withdrawing from a pension may incur income tax unless taken from tax-free cash.
- Gifting other investments may trigger CGT.
- Leaving assets in a pension allows them to continue growing tax-free, though beneficiaries will pay income tax on withdrawals if you die after age 75.
Therefore, it’s important to take advice as to whether this is suitable in your circumstances, and which method is best for you.
Gifting from Surplus Income
One of the most tax-efficient ways to pass on wealth is by gifting from surplus income, which is immediately exempt from IHT if:
- The gift comes from income, not capital.
- It forms a regular pattern of giving.
- It does not reduce your standard of living.
Regular withdrawals from tax-free pension cash could count as income under this rule, helping to reduce your estate’s taxable value over time. However, one-off lump sums may not qualify.
To ensure you don’t fall foul of these rules you should seek advice in this regard.
Maximising Pension Withdrawals
There are several ways to make the most of pension withdrawals:
- Use withdrawals to fund life insurance to cover IHT liabilities.
- Gift withdrawals with protection policies in place to cover a potential IHT liability.
- Reinvest withdrawals into ISAs or pensions for children or grandchildren, ensuring funds remain tax-efficient.
- Use withdrawals to pay for grandchildren’s education via trusts or tax-efficient bonds.
While reducing IHT exposure is important, financial security in retirement should remain the priority. You should ensure you have enough to cover future expenses, including long-term care.
BHP Financial Planning can help you determine exactly what that amount might be and the most effective option for your circumstances.
Getting advice
Pensions have only been a viable wealth transfer tool since 2015, following pension freedoms. Before then, death benefits could be taxed at up to 55%. The inclusion of pensions in IHT is a setback, but with careful planning, there are still opportunities to pass wealth efficiently to future generations.
If you are concerned about these changes, now is the time to review your estate planning strategy. BHP Financial Planning will explore your options with you and ensure your wealth is passed on in the most tax-efficient way.
These changes aren’t finalised and won’t take effect until 6 April 2027.
BHP Financial Planning Limited is authorised and regulated by the Financial Conduct Authority.
