Pensions and Inheritance Tax: The Huge Changes Coming in April 2027 Explained
Reminder overview of inheritance tax
Inheritance tax is such an emotive but often vastly misunderstood tax – therefore, before we get into the changes to the inheritance tax treatment of pension funds on death, it is worth reminding ourselves of the basic principles of inheritance tax. As Tax Specialists and a Chartered Tax Advisor team within an Accountancy Firm in Cornwall, we regularly advise clients on these issues.
Inheritance tax (IHT) is payable on certain lifetime chargeable transfers (namely transfers to non-individuals) and on death. On death, it is the duty of the deceased’s Personal Representatives to collate the assets in the deceased’s estate and prepare papers to obtain the Grant to enable the Personal Representatives to act and to pay any IHT due on the value of the deceased’s estate. See RRL Probate’s article here for a comprehensive explanation of this process.
Providing the deceased was UK “long-term UK tax resident” for UK inheritance tax purposes (this is complicated and outside the scope of this piece – but we are experienced in advising clients and Personal Representatives on this specific point, acting as Tax Specialists and Probate Specialists for clients across Cornwall), the chargeable value of the deceased’s worldwide assets fall into their chargeable estate for UK IHT purposes. If the deceased was not “long-term UK tax resident” it is likely only their UK assets will be subject to UK IHT (something for non-UK tax residents to watch and be aware of – RRL Probate has experience of dealing with UK Probate and Estate Administration for estates of those not “long-term UK tax resident”).
Currently (and until midnight on 5 April 2027), the vast majority of unused pension funds are not chargeable to IHT on death.
The current rate of IHT is 40% and the IHT nil-rate band (upon which no IHT is payable) is currently £325,000 per tax-payer (the standard nil-rate band) – this level frozen until at least 2031.
Gifts made by an individual within the final 7 year period (ending on the date of death) of their life are also treated as falling within the individual’s chargeable IHT estate.
Any value transferred to a person’s spouse is exempt from inheritance tax by virtue of the spousal exemption. Consequently, any of the person’s nil-rate band that is left ununused on their death can be transferred to the surviving spouse to be offset against their chargeable estate on their death.
Any value transferred to charity is also exempt for inheritance tax purposes, and in addition a specific relief can apply to reduce the rate of IHT (to 36%) on the qualifying element of the chargeable estate.
There are various IHT reliefs available, the main reliefs being Agricultural Property Relief (generally applies to agricultural land and property) and Business Property Relief that are available (albeit, crucially, not to assets within a pension) in respect of certain qualifying assets and certain situations – albeit 100% relief is now capped at a £2.5m value per individual (see our previous article here). There are minimum ownership periods required for such assets to qualify for these reliefs.
An additional nil-rate band called the residence nil-rate band (RNRB) is also available for an estate that includes an interest in a residential property which was used by the deceased as their residence at some point, and this is left to direct descendants (to include child, step-child, adopted child or foster child). The value of the residence nil-rate band (RNRB) is the lower of:
- the net value of the interest in the property (after deducting any liabilities e.g. mortgage); and
- the maximum amount available (per band limits shown below).
The maximum RNRB available per individual is £175,000.
Importantly, the RNRB is restricted and tapered away by £1 for every £2 that the net value (after liabilities but before reliefs and exemptions) of an estate exceeds £2,000,000. After 5 April 2027, this will include the value of unused pension savings.
As with the standard nil-rate band, any unused residence nil-rate band on the first spouse death will be capable of being transferred to the surviving spouse estate by way of a claim made by the personal representatives of the surviving spouse.
Pension funds on death becoming subject to inheritance tax – A huge change!
A huge change to the inheritance tax treatment of unused pension funds at death is coming on 6 April 2027, effectively making values of pension funds on death subject to inheritance tax where the vast majority haven’t been, and aren’t currently.
This represents a huge change to many people’s current exposure to inheritance tax – adding more value to their chargeable estate.
Impact of these changes
Potential significant increase to exposures to inheritance tax at midnight on 5 April 2027
We are urging clients to consider their inheritance tax positions post the implementation of these changes on 6 April 2027 and review their succession/estate planning strategies – which will be urgently required given that these changes turn many previous strategies on their head. A Chartered Tax Advisor can help assess the impact of these changes on individual circumstances.
IHT is a specialist area and care should be taken to seek advice from experienced advisors who are capable of advising on the whole position. Working with Tax Specialists and a Chartered Tax Advisor can help ensure opportunities and risks are properly identified.
Resulting changes to planning strategies
Many have rightly used the existing inheritance tax exemption for the vast majority of inherited pension funds to build up pension funds, leave them to accumulate and remain undrawn, to leave to their nominated beneficiaries free of inheritance tax (albeit potentially still subject to income tax, depending on whether the policy holder dies before the age of 75 or after).
Given the current inheritance tax exemption for most unused pension funds on death, pensions funds have always been the last pot of wealth to use/spend, and using other assets to fund living expenditure etc in retirement. However, the removal of the exemption changes this.
Those with pension funds will likely want to use those funds, for living expenditure and carry out lifetime inheritance tax planning with other assets in their estate (which now also includes assets qualifying for Business Property Relief and Agricultural Property Relief given the changes to those reliefs).
Even if policy holders don’t need the funds, they may decide to draw from the pension funds and engage in inheritance tax planning with the income – potentially using the IHT ‘Normal Expenditure Out Of Income Exemption’ (care needs to be taken here as this exemption is complex and much more nuanced than many appreciate – we can provide specific advice to mitigate the risk of the exemption not being available).
Whilst many are concerned about the withdrawals being subject to income tax at the higher-rates of income tax to save inheritance tax at the current rate of 40% (where the estate value (including pension funds on death after 5 April 2027)), however, the position is more nuanced than this given:
- That withdrawals from the fund by the beneficiaries will be subject to income tax where the policyholder died after reaching the age of 75 – the double impact of IHT on the pension fund and the income tax liabilities of the beneficiaries results in very high effective tax rates; and
- The pension fund could mean that the value of the chargeable estate loses the availability of the RNRB (taking the estate’s chargeable value above £2,000,000) – resulting in a much higher effective rate of IHT on some of the value.
The change may also drive investment decisions – maybe pushing some back to considering annuities where they had maybe previously lost their attractiveness. Discussions should be had with your financial adviser regarding the impact of the change from an investment strategy perspective.
As ever, there is no “one size fits all” approach here and each person (or married couple/civil partnership) should seek bespoke advice, linking in with all of their relevant professional advisers.
Much more complex and risky for Personal Representatives
This change inevitably brings much more complexity and risk to a a probate and estate administration process that is already complex and carries a degree of risk for Personal Representatives.
Personal representatives are personally liable for reporting and paying IHT for the deceased’s estate (including being liable for underpaid IHT – this could now include IHT on unused pension funds on death).
The fundamental challenge for Personal Representatives with the pension funds becoming chargeable to IHT is that they are liable for the IHT liability on an asset (the pension fund value) that they cannot control.
The complexities and risks increase where the estate and pension fund are to be distributed to different beneficiaries – which will not be uncommon.
There will also be complexity and risk in ensuring that all of the pension savings of the deceased are identified. We would advise clients to ensure that they have done work to identify their pension savings during lifetime and keep this updated to assist their Personal Representatives when this information is required.
Managing this risk and dealing with the additional administration required will need to be managed by Personal Representatives and it will be very prudent for many non-professional Personal Representatives to seek quality professional advice and assistance to adequately manage this risk and ensure a robust process. We at RRL (in RRL Probate), as Professional Probate Specialists can assist with these increasingly complex requirements.
We are already, proactively putting processes in place to manage the new processes to ensure robust management of probate and estate administration work post 5 April 2027 – adhering to the announced processes and mechanisms (and crucially, timings of those) available to Personal Representatives.
Additionally, management of the desire of beneficiaries to be distributed funds on a timely basis against the need for robust management by the Personal Representatives to not distribute all of the free estate until they have sufficient comfort on the IHT position, and that of unused pension funds in particular.
Wills may need to be updated
Some knock-on impacts to the currently intended working of the terms of Wills have been identified, these include:
- The wording in Wills around charitable gifts will likely be impacted – particularly where the intended distribution is phrased as a % percentage of the estate.
- Reviewing any specific gifts for an amount equal to the nil-rate band. Some of the nil-rate band could now be allocated to the pension fund, therefore such clauses should be reviewed in light of this.
- Considering the impact of the changes on the availability of the RNRB (see above).
- A review of assets held within pension funds that have the capability to qualify for IHT Agricultural Property Relief or Business Property Relief should be undertaken, and if assets could qualify, restructuring ownership of those assets should be considered.
Solicitors in RRL Wills (a Solicitors Regulation Authority regulated legal business) are available to RRL clients to assist with Will drafting and work closely with their tax advisory colleagues in RRL to ensure a robust, complete service – ensuring all aspects are covered. This joined-up approach between Probate Specialists and Tax Specialists can be particularly valuable for complex estates.
Non-UK long-term residents will need to consider a potential exposure that they didn’t have before
UK pension savings held by non-UK long-term tax residents are not currently exposed to UK IHT, but will potentially be (subject to nil-rate bands etc) from 6 April 2027. Any opportunities to restructure these savings should be considered. Clients in Cornwall and across the UK should seek advice from an experienced Tax Advisor where these changes may affect their estate planning.
Frequently Asked Questions
Will pensions be subject to inheritance tax from April 2027?
From 6 April 2027, most unused pension funds and death benefits will form part of an individual’s estate for inheritance tax purposes. This represents a significant change from the current rules.
How much inheritance tax could be payable on pension funds?
Inheritance tax is generally charged at 40% on the value of an estate above the available nil-rate bands and exemptions. The inclusion of pension funds may increase the overall inheritance tax liability of an estate.
Could pension funds affect the Residence Nil-Rate Band?
Yes. Including pension funds within the chargeable estate may increase the estate value above £2 million, potentially reducing or eliminating the Residence Nil-Rate Band through tapering provisions.
Should I review my estate planning before April 2027?
Many individuals are reviewing their estate planning and succession strategies ahead of the changes. The most appropriate action will depend on personal circumstances, family arrangements, asset values and retirement objectives.
Will beneficiaries still pay income tax on inherited pension funds?
Potentially. Where the pension holder dies after age 75, beneficiaries may still be subject to income tax when withdrawing funds. This means pension funds could be affected by both inheritance tax and income tax.
Should I seek professional advice regarding the pension inheritance tax changes?
Inheritance tax and estate planning are highly specialised areas. Seeking advice from experienced Tax Specialists, Probate Specialists and a Chartered Tax Advisor can help ensure that planning opportunities and risks are properly considered.
