For many years it has been possible to pass pension funds to beneficiaries after death free from inheritance tax (IHT). However, from April 2027 that will change with pensions falling into the IHT net.
Currently, if an individual dies before the 75th birthday any unused pension can be passed on free from IHT. If that person were to pass away after their 75th birthday, any unused pension will be passed on free from IHT although the recipient will pay income tax on any cash sum or income they receive from it.
The Chancellor in her Autumn budget changed that, meaning that if pensions bring the value of an estate above the £325,000 nil rate band (or £500,000 with the residence nil rate band), the excess will be subject to IHT at 40%.
The changes relate to defined contribution (DC) and defined benefit (DB) pensions and closes what the Labour government calls a “loophole” created by the previous government that has seen schemes used “as a tax planning tool rather than for funding retirement”.
It means that the value of pension schemes must now be considered when calculating the overall value of an estate before any IHT is due, with estate trustees and advisors working much more closely with pension professionals.
What is changing?
From 6 April 2027:
• Most lump sum death benefits will form part of an individual’s estate for IHT, with income tax continuing to be paid on lump sum death benefits if that individual dies after their 75th birthday.
• Unused drawdown funds will also fall into a member’s estate for IHT, with income tax still payable.
• Dependents’ schemes will, however, remain outside an individual’s estate, with each pension payment subject to income tax.
Whilst much of the detail has yet to be clarified – a consultation was published on 30 October – it appears to mark the end of a favourable tax regime for pension benefits on death to one that is punitive.
Given that the changes will not take effect until April 2027 there will be opportunities for individuals to plan and prepare for these changes, once the results of the consultation are known.
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