You may have read the previous article we published that considered how the recent UK Budget on 30 October could affect your finances.
One big change in the Budget that we flagged up was that your pensions will become liable for Inheritance Tax (IHT) from April 2027.
Now the dust has settled, it’s clear that this is the most impactful Budget change from a retirement and estate planning perspective.
So, in this article, read more about the change and how it could affect you, and why it’s imperative to review your financial planning arrangements to ensure you’re ready for the adjustment when it occurs.
Your UK pension fund will be liable for Inheritance Tax from April 2027
Since 2011, when the obligation to buy an annuity with your pension fund when you reached age 75 was abolished, pensions have provided you with a highly effective option to help mitigate your IHT liability.
This is because the trust status of most pension schemes means that they sit outside the value of your estate. So, accruing money in your pension fund has been a highly advantageous way to pass a substantial sum to your beneficiaries, with no IHT payable.
This was accentuated in 2023 when the Lifetime Allowance charge – which limited the total amount you could accumulate tax-efficiently in your pension –was abolished, and then the threshold ultimately removed in April 2024.
However, plans to include inherited pensions for IHT purposes from April 2027 will end this arrangement.
This makes pensions a far less efficient option when it comes to your estate planning arrangements, and you may need to consider alternative ways to mitigate your IHT liability.
A change in thinking for retirement and estate planning
If you were planning to use your retirement fund as a means to pass assets tax-efficiently to family members other than your spouse after your death, you will likely need to review your arrangements.
Effectively, you will need to use your pension for the purpose for which, by definition, it’s intended: to provide income in retirement.
You may well need to balance conflicting needs to provide yourself with a tax-efficient income from your retirement fund, while also minimising the amount of IHT payable by your beneficiaries after you die.
Any changes you make to your financial plans will clearly depend on your financial circumstances.
There are effective ways of reducing IHT liability on your pension fund
There are a range of financial planning measures you could take to help mitigate the potential IHT liability on your pension fund.
For example, your spouse or civil partner will inherit your pension free from IHT, which could enable them to remove pension assets from the value of your combined estate prior to their death.
Two other options are:
1. Purchasing an annuity
Using some or all of your retirement fund to purchase an annuity will provide you with a guaranteed income that you can choose to have increase each year in line with inflation.
You can also provide a reduced income for your spouse or civil partner if you pass away first. Importantly, the funds you use to purchase the annuity will no longer form part of your estate. However, if you save any of the annuity income, it will be included in your estate’s value.
2. Accelerating drawdown income
By making “gifts out of surplus income” from your pension fund, you will reduce the value of your IHT liability. As long as the gifts are regular and don’t affect your standard of living, they will fall immediately outside of your estate.
This also means that you can pass some of your wealth to your beneficiaries for specific purposes, such as school fees for their children. Just remember, these cannot affect your standard of living and must be regular payments rather than one-off amounts.
There are other effective estate planning measures you can utilise
IHT is payable at 40% on the value of your estate in excess of your £325,000 nil-rate band. You may also be able to apply for the additional residence nil-rate band of £175,000 if you pass on your main residence to children or grandchildren.
You can combine your nil-rate bands and transfer assets between yourself and your spouse IHT-free, which means that you have an overall IHT threshold of up to £1 million on the combined value of your estate.
Even though you will no longer be able to use your pension funds as part of your legacy planning, there are other ways that you can reduce your IHT liability.
These could include:
- Using your annual gift exemption, which is currently £3,000 in the 2024/25 tax year. You can also bring forward any unused exemption from the previous tax year. This means that you and your spouse or civil partner could immediately gift £12,000 and reduce the value of your estate by this amount.
- Making other large gifts of your assets, which are known as potentially exempt transfers, (PETs). No IHT will be payable on these gifts if you survive for seven years after making the transfer.
- Calculating your IHT liability and setting up a life insurance plan for this amount, payable on your death. However, you need to ensure this is held in trust, otherwise the benefits paid will be added to the value of your estate and subject to IHT.
It is also possible to remove assets from your estate by putting them in trust. The type of trust you use will depend on your circumstances and objectives, so it’s sensible to take expert advice before doing this.
Professional advice is essential
The changes you have read about here could have significant implications for both your retirement and estate planning.
Although they are not due to come into effect until April 2027, reviewing your arrangements now will give you plenty of time to make any adjustments to your existing plans prior to this date.
We would strongly recommend that you get expert advice, as any measures you take are liable to be irreversible, so mistakes could prove costly to your beneficiaries.
Get in touch
If you would like to discuss your own pension and estate planning arrangements, please get in touch with us.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
This article is for information only, it does not take into account your personal objectives, financial situation, or needs. Please do not solely rely on anything you have read in this article and ensure that you conduct your own research to ensure any actions you may take are suitable for your circumstances.
The Financial Conduct Authority does not regulate estate planning.
All contents are based on our understanding of HMRC legislation, which is subject to change.