Disregarding the constant stream of tax rumours coming out from the Government currently (which deserves a separate article), the new proposed inheritance tax (IHT) rules on pensions is the hottest topic in financial planning right now.

It is however too big a subject to cover in one article. So in this edition I am going to discuss some general concepts and planning thoughts.

As a quick recap, in her first budget as Chancellor in 2024, Rachel Reeves made the announcement that from April 2027, IHT will apply to pension funds on death. This has set the hares running in the media.

For the past 10 years pensions have been an extremely efficient vehicle for tax planning, given the inheritance efficiencies. ‘Take your pension last’ has been a common mantra.

From April 2027 though, this will change and effectively means pension funds will now become the least efficient vehicle within a portfolio when it comes to estate planning. 

The draft legislation following the consultation on this subject was released in July and while the hope of a full U-turn did not transpire, there has been some clarity provided to some of the less certain areas.

Clarity but added complexity

We now know that:

• Death in service benefits will not be included and will remain exempt.
• Pension benefits on death before minimum pension age will be included which seems harsh (in our view).
• The responsibility of the calculations will fall on the personal representatives. Payment of the tax will fall on the personal representatives and non-exempt beneficiaries jointly. This means estate administration after death will now be more involved and complicated.
• Death benefit payments under an annuity guaranteed period are revalued and added back into the estate for evaluation.
• Benefits received from a death prior to age 75 will still provide a tax-free income to the beneficiary whether to the spouse or other beneficiaries.

Key planning points

With the rules so new and fresh, we are still getting to grips with the impact on different scenarios and what planning could make sense, but here are some initial thoughts:

• Pensions are still efficient to build retirement savings whilst working but are no longer efficient for leaving legacies. Therefore, it might be necessary to consider the order in which income is generated from assets in retirement.
• Pensions inherited by spouses are still exempt from inheritance tax so a review of nominations and letters of wishes in favour of spouses should be considered as this could provide greater time and flexibility in dealing with the estates tax liability.
• From April 2027, the value of pension funds when added into the estate will count towards the tapering test for the Residence Nil Rate Band potentially causing an even greater liability.  So expenditure and gifting to protect this should be a consideration.
• The cost of an annuity will immediately reduce the estate value, and a death benefit that passes to the spouse will not have consequences.  However, where a guaranteed period is chosen, there could be an amount added back into the estate which is an actuarial calculation to work out the present value cost of that annuity on death.  This could have unintended consequences as the future value is unknown now which makes planning difficult.
• Estate administration is going to be much more complicated, especially where there is more than one pension fund involved, so consolidation to one solution will be a good idea for most. 
• Collaboration with other advisers in legal and tax will likely be needed even more than currently.
• Drawing from pensions to make gifts can help and greater tax efficiency can be provided if the recipient of the gift post withdrawal (children) then top up their own pension fund.  It is a useful way of gifting with a long-term benefit and an immediate tax offset for the family.

Where does this leave us?

This is a significant change to what has been a stable set of rules for the past 10 years and for many of our clients it is going to likely lead to a change to the advice we have always given.

It again demonstrates the need to have a diversified portfolio, not just from an investment perspective, but also with respect to tax rules and future interventions from policy makers.

We will be having these discussions with you at our review meetings. Nothing actually changes until April 2027, but we should certainly be considering the correct advice in the lead up to this.

I hope this has been informative, and I am sure we will release more information as the industry gets to grips with the legislation and we deal with more advice cases.  Please contact your usual planner if you have any specific questions regarding your own situation.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.

Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances.

Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts. 

Your pension income could also be affected by the interest rates at the time you take your benefits.

The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.