Pension and inheritance tax changes — what you can do to take action now

The proposal to bring unspent pensions into estates and include the funds in Inheritance tax rules still has to be passed into law, and there is a chance it might not happen. But it most likely will.

The Government said it wants to continue to offer tax incentives for people saving into pensions, such as tax relief on contributions. But it wants to include pensions into estates to encourage savers to use the funds during retirement, rather than leaving them untouched as a way to pass on wealth inheritance tax free.

There is a lot of opposition to these changes with industry experts trying to persuade the Government to drop its plans.

Pensions are already complex and this would add yet another layer of complication which could put people off saving for their older age – just when more people are engaged with pensions than ever before.

Meanwhile, the extra administrative issues this will cause could mean lengthy delays before beneficiaries receive their money.

It could lead to additional costs and the risk of interest charges from if the process takes longer than six months – the deadline for paying IHT bills.

A double whammy will hit many as the amount everyone can pass on inheritance tax-free (the nil rate band) has been frozen at £325,000 for two years longer than planned, until 2030 instead of 2028, pushing more people into paying more IHT.

What happens now

Currently pensions are not included when totting up the total value of your estate (assets, investments, property, savings and personal items) and therefore are not subject to IHT.

There can be income tax to pay on inherited pensions, depending on your age when you die.

If you die before age 75, your pension can be inherited tax-free

If you die aged 75 and over, beneficiaries will pay income tax on the inheritance at their personal tax rate (20%, 40% or 45%).

What the changes could mean

The final details of how IHT on pensions will work haven’t been announced. It is due to come into force in 2027.

From April 2027 unspent pension funds will be included in the total value of your estate. If the value is above the £325,000 nil rate band (or £500,000 if you are leaving your home to a direct descendant) any funds above that threshold will be liable for IHT at 40%.

The big issue is not paying Inheritance Tax on pensions but that the funds could be double-taxed if they are passed on from age 75.

As not only will IHT happen but beneficiaries of those 75 and over will have to pay income tax at their personal tax rate, so some may be hit with a 20%, 40% or 45% tax bill on top of the IHT. That could mean some pension pots are depleted very quickly.

What you need to know about exemptions

Most unused pensions and pension death benefits will be included in the total value of an estate but there will be exceptions for dependant’s pensions from final salary (defined benefit) pension schemes and eligible lumps sums to charities.

And there is the ‘spousal exemption’ which means anything left to a spouse or civil partner will be exempt from inheritance tax, that includes a pension.

Eight steps you can take right now to plan for IHT & pension changes:

1. Start spending and enjoy the money that you have accumulated
2. Pensions: You may want to consider changing your beneficiaries (for example nominating grandchildren). This way if you are over the age of 75, when the pension passes down to the next generation you might be able to take advantage of using grandchildren’s personal allowances or lower tax bands to reduce the tax implications.
3. Considering debt as part of your estate. Often, we have spent our whole lives paying off mortgages, for the irony to be that debt can be a good when looking at your estate from an inheritance tax perspective. This is because debt reduces the overall value of your estate and subsequently reducing the inheritance tax liability.
4. You might want to consider making gifts within your lifetime. One of the most unused methods is gifting out of unrequired surplus income, there is no limitation on the amount you can gift nor any timeframe before it is outside of your estate.
5. Make sure you have a will that is up to date and aligned to your wishes.
6. If you leave 10% or more of your estate to charity your rate of inheritance tax reduces from 40% to 36%. Might want to consider donating to charity as part of your estate plan to benefit from tax reduction.
7. Seek advice from a financial adviser or professional accountant who can help you decide if you may need to diversify your retirement savings or make any changes to your will and beneficiaries.
8. Keep up to date as details may change as the proposals make their way through Parliament.

Frankie Smith runs FSWM (), one of a very few female-run, independent wealth management firms, and Frankie’s, a networking organisation that runs regular events where people can improve their financial know-how.

She is passionate about moving the advice industry forward and making it accessible to a much wider audience.