The latest UK Autumn Budget reform to count pensions as part of your estate for Inheritance Tax (IHT) is a considerable change and will impact many.
At present, most pension benefits payable on death – whether lump sums or other income – are outside the scope of IHT because they aren’t included in your estate. There is also an Income Tax charge on the beneficiaries when they receive the pension monies and death occurs on or after age 75, and in certain limited cases before age 75.
The reform sees the value of nearly all pension death benefits counted as part of an estate and is set to start on 6 April 2027. Lump-sum death-in-service supplied by employers and drawdown funds left over at death will be included too.
HMRC calculations
HMRC estimate that 38,500 estates will pay more IHT than before, which means many will need to reconsider their estate plans as soon as possible. HMRC also project that in the 2027/28 tax year (the first under this new reform) 10,500 additional estates will become liable to IHT that wouldn’t have before.
The amount of IHT these additional 38,500 estates will pay is projected at a sum of £34,000, which works out at a 20% rise.
Whilst Income Tax principles aren’t changing, Income Tax bills might. Income Tax will carry on applying to most death benefits upon access, however this will be based on the amount after IHT has been deducted. The example below highlights the relationship between IHT and Income Tax:
Example 1: Interaction between IHT and Income Tax:
Samuel dies at age 80 in June 2007 with an estate of £750,000, plus pension pot valued at £200,000, which will pass with the rest of his estate to his nephew, Peter, an additional rate taxpayer.
The total tax would be:
Rest of estate | £750,000 |
Pension | £200,000 |
Total | £950,000 |
Nil rate band | (£325,000) |
IHT due on estate | (197,368) |
IHT due on pension | (£52,632) |
Income tax on net pension of £147,368 at 45% | (£66,316) |
Net of taxes on estate | £633,684 |
In this example, if Samuel didn’t have a pension pot, Peter would receive £580,000. Meaning, the £200,000 pension pot puts another £53,684 in Peter’s hands, albeit at an effective total tax rate on the pension of 73%.
The effective rate can be even higher, something which commonly happens when pension surplus on an estate boosts its value over £2 million, triggering the loss of some/all of that residence nil rate band.
Please remember that the residence nil rate band can only be claimed if a main residence is passed onto a direct descendant on death and so in this scenario, as Peter is Samuel’s nephew, this is not available to him.
Getting prepared
While administration of these new rules may be adjusted in response to consultation before April 2027, there’s little chance this principle will be thrown out. The revenue raised is estimated to be nearly three times as much as from the other Budget updates, such as agricultural relief and business reforms.
Therefore, it’s important to prepare for these tax changes as soon as possible and make the necessary adjustments to your estate and financial plan. It may be prudent to review your Will as part of this proactive estate planning process. If you’d like to consult a financial and legal professional about your pensions and Inheritance Tax, our team are here to help you. Please contact us here.
Important Note
The information contained within this document is subject to the UK regulatory regime and is therefore primarily targeted at consumers based in the UK.
This article is distributed for educational purposes only and should not be considered financial advice.
If you are unsure about the suitability or otherwise of any product or service, we recommend that you seek professional advice.
The opinions stated in this document are those of the author and do not necessarily represent the view of Progeny and should not be relied upon to make a financial decision.
Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Tax treatment depends upon individual circumstances and is based on current UK tax legislation, that is subject to change at any time.
