From April 2027, significant changes to the treatment of unused pension funds and death benefits under Inheritance Tax (IHT) rules will come into effect. These changes to Inheritance Tax on Pensions, announced in the Autumn Budget 2024, aim to bring pensions in line with other inherited assets, but they could have implications for estate planning strategies. Below, we consider the details of these changes, their impact, and practical steps to take.

Current IHT rules for pensions

Under the current system, unused pension funds are generally exempt from IHT, making them a popular tool for estate planning. This exemption applies as long as pension scheme trustees or administrators have discretion over how death benefits are distributed. Beneficiaries can inherit pension wealth without it forming part of their taxable estate, and spousal exemptions further protect these funds from IHT.

What’s changing in April 2027?

From 6 April 2027, unused pension funds and death benefits will be included in a deceased individual’s estate for IHT purposes.

This change applies to both defined contribution (DC) and defined benefit (DB) schemes, as well as lump sum death benefits paid at the discretion of trustees.

Key exemptions include:

• Dependents’ scheme pensions
• Charity lump sum death benefits
• Funds passed to a spouse or civil partner under the spousal exemption.

Under the new rules:

• Pension Scheme Administrators (PSAs) will be responsible for calculating and paying IHT on unused pension funds directly to HMRC before distributing benefits to beneficiaries.
• Personal representatives must liaise with PSAs to determine the value of unspent pension assets and allocate allowances accordingly.

What’s the impact on Estate Planning?

These changes are expected to affect around 50,000 families each year, increasing costs and administrative burdens during Probate. Estates that previously fell below the IHT threshold may now be liable due to the inclusion of pension funds. For example:

• The nil-rate band (£325,000) remains unchanged until 2030.
• Estates exceeding this threshold will face a 40% IHT charge on the value above it.

For individuals whose estates already exceed the nil-rate band, pensions may increase their tax liability. This could lead beneficiaries to face both income tax AND inheritance tax on inherited pensions if the deceased was over 75 years old at the time of death.

Practical steps to take…

To prepare for the changes, consider the following steps:

1. Review Your Estate Plan: Assess how your pension assets fit within your overall estate. If your combined estate value exceeds £325,000 (or £1 million for couples using transferable allowances), explore alternative strategies.
2. Consider Decumulation Strategies: Drawing down pension funds earlier or utilising other assets like ISAs may reduce your taxable estate while maintaining retirement security.
3. Evaluate Trusts and Exemptions: Lump sums paid into bypass trusts will no longer escape IHT under the new rules. However, life insurance policies written in trust remain outside IHT scope and could provide a tax-efficient alternative.
4. Engage with Pension Scheme Administrators: Ensure your executors or administrators understand their responsibilities under the new rules.
5. Plan for Probate Delays: The added administrative steps may delay probate proceedings. Preparing in advance can minimise financial difficulties for beneficiaries.

What are these changes being made?

The government has stated that these reforms aim to address a ‘distortive’ tax regime that incentivised using pensions as a wealth transfer tool rather than for retirement savings.

By aligning pensions with other inherited assets, they hope to create a fairer system while increasing revenue from estates subject to IHT.

If you’re concerned about how these changes might affect your estate planning or business succession plans, get in touch.