What’s changing to inheritance tax on pensions from April 2027?

The UK inheritance tax (IHT) treatment of pensions changes fundamentally from 6 April 2027. Most unused pension funds and pension death benefits will be brought within the value of the deceased’s estate for IHT purposes. Currently, these assets are passed on IHT-free. The changes apply to both UK registered pension schemes and certain foreign pension plans.

Until now, individuals were generally advised to access pensions in retirement only after exhausting other wealth (which would otherwise attract IHT). These changes mean a new approach to IHT planning is required, so what can you do?

What happens to my pension when I die?

From April 2027, the value of your ‘notional pension property’ (‘NPP’) will be included in your estate. NPP is broadly equivalent to the funds that you would have been entitled to on your death including:

• Undrawn funds remaining in defined contribution pension pots.
• Death benefits payable under defined benefits plans.
• Some annuities that continue after death.

In addition, where death happens after the age of 75, the beneficiaries will pay income tax on the income taken from the pension fund (which is the same as the treatment under the current law).

In the worst-case scenario, the overall tax charge for some pension funds (including both IHT and income tax) reaches a whopping 67%. In other words, there is a massive incentive to do something to prevent a huge tax liability.

Reviewing your IHT planning

Anyone with a pension who expects their wealth to be subject to IHT should take advice on their IHT planning.

Because assets can be inherited by a spouse IHT-free, the difficult choices around who receives a couple’s wealth are often left to the surviving spouse. There will be no change to the current position relating to pension assets on death received by the surviving spouse - the NPP will remain exempt from IHT. If the deceased spouse died after the age of 75, the surviving spouse will pay income tax on funds received.

From April 2027, this may not be the best use of pension assets if the surviving spouse will have sufficient wealth from other sources. It may also be less attractive where the surviving spouse pays income tax at higher rates. You should consider whether pension funds would be better used by your children or grandchildren, and whether they should have access to those funds during your lifetime, or on your death.

Using pension income to benefit the next generation

If you access your pension during your lifetime, you will pay income tax on receipts which are not included in the income tax-free amount. If your pension creates surplus income, you may be able to give it away IHT-free immediately.

There is no seven-year wait providing a regular gifting pattern is established. This will avoid the penal 67% overall tax and effectively accelerates the gifting of funds to your heirs. Gifts before your death might enable children or grandchildren to pay down student loans, reduce their mortgage or perhaps give them breathing space to make their own pension contributions.

A word of warning; the income tax-free amount itself may not be treated as surplus income by HMRC and if given away, could be subject to the seven-year tail.

A different approach might be to use some of the pension income to pay life insurance premiums. If it is structured correctly, the insurance will provide an IHT-free sum to your heirs on your death.

Death benefits and planning

Leaving your pension to your heirs on death, potentially solves a different problem. Unlike your own pension savings, pension death benefits can be accessed at any age; you do not have to be 55 to receive benefits. You could view this as a long-term tax-free savings plan for your children or grandchildren.

The appeal of this strategy depends on your age at death. With death before the age of 75, beneficiaries can generally access pension benefits free of income tax, making this a particularly attractive option. From age 75 however, the pension may be subject to both IHT and income tax with the potential for an effective 67% tax charge to apply. The suitability of this strategy should be revisited periodically as you get older.

It is also possible for the IHT associated with the value of the pension fund to be paid from pension assets. But is this sensible? Where beneficiaries are likely to pay income tax on pension withdrawals, allowing the IHT attributable to the pension to be settled from pension funds will often be more tax-efficient. However, where death occurs before age 75 and pension benefits can be drawn free of income tax, preserving the pension fund and meeting the IHT liability from other assets may be preferable.

International pension schemes and IHT

It is not just UK registered pension schemes that will be affected by the upcoming changes.

Qualifying non-UK pension schemes (‘QNUPS’), which include qualifying recognised overseas pension schemes (‘QROPS’) will also come within the charge to IHT from April 2027. Any NPP held in these offshore plans will be within the scope of IHT for individuals who are long-term resident (‘LTR’). LTR is defined as those who have been UK tax resident in 10 of the past 20 tax years. This will also apply to those who are not UK tax resident but are within a ‘tail’ period ie they remain liable to UK IHT on their worldwide assets despite being non-resident.

It’s important to establish whether your foreign plan is a QNUPS. If it is, and you are LTR, the planning suggestions outlined here are worth serious consideration. For those who are not LTR, consider an IHT strategy which depletes UK assets in priority.

Business owners and commercial property

Many business owners have historically chosen to hold commercial property via their personal pension plans due to the tax benefits including the potential for tax efficient profit extraction.

From 6 April 2027, holding commercial property this way might be detrimental. Neither business nor agricultural property relief will apply to qualifying assets held in a pension, resulting in full exposure to IHT. In contrast, if the asset were owned personally, or by the individual’s company, relief at 50% or 100% could be available.

The second challenge relates to payment of the IHT liability. If it is to be paid out of pension funds, and those consist almost exclusively of commercial property, these assets may need to be sold to fund the IHT due. This could be a disaster if the family are still running the business from the commercial property in the pension fund.

Key IHT takeaways

The changes to pensions and IHT are significant and you should consider now what changes are required to your plans. At the very least, you may wish to ensure that your death benefits nomination form includes wider family members rather than just your spouse. There are complexities (both tax and non-tax) and seeking advice now should allow time to take any actions needed ahead of the April 2027 changes.

If you have any questions on IHT planning and pensions, please contact Rachel de Souza or your usual RSM contact.

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