Pension Planning Is About to Change: April 2027

For many years, pensions have enjoyed a unique advantage in estate planning. Savings, investments and property would normally be included in an individual’s estate for Inheritance Tax (IHT) purposes. Unused pension funds could often pass to beneficiaries outside the scope of IHT. As a result, many people preserved their pension wealth for as long as possible, drawing on other assets instead to fund their retirement.

From 6 April 2027, that approach may no longer be appropriate.

The Government is bringing most unused pension funds and death benefits within the IHT regime. As a result, pensions will no longer provide the same IHT exemption benefits on which many families have relied upon when planning how wealth will pass between generations.

What Do the New Rules Mean?

For deaths occurring on or after 6 April 2027, the value of most unused pension funds will be included when calculating the value of a deceased person’s estate for IHT purposes. This means that pension wealth may be subject to the same 40% IHT charge that already applies to many other assets.

The change is particularly significant for individuals who have intentionally retained large pension balances whilst spending ISA portfolios, investment accounts and other taxable assets during retirement. Historically, this was often regarded as sensible planning because pension funds could frequently pass to the next generation free from IHT.

• Protection for Spouses and Civil Partners:

The existing spouse and civil partner exemption is being extended to include the value of unused pension funds on death.

This means that, where the value of pension benefits passes to a surviving spouse or civil partner, they can continue to benefit from the normal IHT exemption available between spouses and civil partners. For many married couples and civil partners, this will continue to defer any IHT liability until the second death.

• The beneficiary bears the IHT, but the executors deal with the administration:

One unusual feature of the new regime is that the financial burden and the administrative responsibility fall on different parties.

The IHT cost will ultimately be borne by the beneficiary receiving the pension funds. Responsibility for calculating, reporting and paying the IHT will generally rest with the executors or personal representatives administering the estate. Pension providers will assist with the process. However, the additional compliance burden is likely to make estate administration more complex as a result.

• Business and Agricultural Assets Need Particular Attention:

Many business owners and farmers have historically held assets such as family company shares, farmland and trading premises within SIPPs or SSASs.

Until now, this has often been IHT-neutral. Had the value of such assets remained in personal ownership, Business Relief (BR) or Agricultural Relief (AR) may have been available. Once transferred into a pension, the pension exemption effectively provided protection instead.

Pension funds will become subject to IHT. The Government has confirmed that BR and AR will not be extended to qualifying assets simply because they are held within a pension scheme.

Planning Opportunities Before 2027

The good news is that there is still time to adapt and plan.

• Review Existing Succession Plans:

Anyone with significant pension wealth should revisit their Will and wider estate planning arrangements. Beneficiaries who inherit the value of pension funds from April 2027 may receive considerably less than originally anticipated once IHT and, in some cases, Income Tax have been taken into account.

In certain circumstances, the value of a pension fund inherited by adult children could be subject to 40% IHT and then Income Tax at rates of up to 45% when withdrawn. This would leave beneficiaries with only around one-third of the original fund value.

• Consider Lifetime Gifts:

For those who hold both pension assets and non-pension investments, lifetime gifting may become increasingly attractive.

Gifts made during a person’s lifetime are often Potentially Exempt Transfers (PETs). Provided the donor survives for seven years from the date gift(s) are made, the gifted assets fall outside the estate entirely. Where death occurs after three years, taper relief may reduce the effective rate of IHT payable.

• Take the Tax-Free Lump Sum:

Many individuals may wish to consider taking their tax-free pension commencement lump sum and gifting the proceeds.

The gift will normally be treated as a PET and could become entirely free of IHT after seven years.

• Withdraw Pension Funds Earlier:

Some individuals may find that withdrawing pension benefits during retirement becomes more attractive than preserving them indefinitely.

Although Income Tax may be payable on withdrawals, gifting those funds could ultimately result in a lower overall tax burden for the family if the donor survives the relevant period.

• Make Gifts Out of Income:

The “normal expenditure out of income” IHT exemption remains one of the most valuable IHT planning tools available. Where surplus income exists, regular gifts to children or grandchildren can be immediately exempt from IHT without any seven-year survival requirement.

• Don’t Forget Age 75:

Retirement planning should not stop once changes have been made. For defined contribution pension holders, a further review should be undertaken as age 75 approaches. While beneficiaries can often inherit pension funds free of Income Tax where death occurs before age 75, Income Tax generally applies to withdrawals made by beneficiaries following a death at or after that age. Combined with the new IHT rules, this can significantly increase the overall tax cost of passing on pension wealth.

The Bottom Line

The inclusion of the value of unused pension funds within the IHT net from April 2027 represents one of the most significant wealth-planning changes of recent years. Strategies that have worked well over the past decade may no longer deliver the same desired or intended results. There are several months remaining before the new rules take effect.

Individuals with substantial pension savings still have time to:

• • Review their arrangements,
  • Consider gifting opportunities,
  • Revisit their Wills,
  • Ensure that their wealth is structured in the most tax-efficient way possible.

Early planning is likely to be more important than ever.

Please Contact Us

We pride ourselves in offering quality, proactive, and timely tax advice and planning services tailored to your needs. Contact your local Whitings office/usual contact to discover how we may able to add value to your affairs.