The Chancellor’s Budget announcement that pensions will fall under inheritance tax (IHT) from April 2027 is poised to reshape financial planning for retirees.
This significant change could see families paying a “double tax” on pensions, with rates potentially reaching as high as 90% in extreme cases.
Here’s what you need to know and how to prepare for these changes.
(Read Time: Approx. 3 minutes)
Topics Discussed:
- The impact of including pensions under inheritance tax and its broader financial implications.
- Strategies to mitigate potential tax liabilities and safeguard family wealth.
The Budget Announcement and What It Means for Pensions
From April 2027, pensions will form part of an individual’s estate for IHT purposes.
For families, this means that unused pension pots and death benefits will face a 40% IHT levy, potentially reducing the funds available for beneficiaries.
This measure is expected to affect around 8% of estates annually and is projected to raise £1.46 billion in 2029/30.
Under the current system, pensions are exempt from IHT, allowing retirees to pass on their pension savings without this additional tax burden.
However, the upcoming change could disrupt traditional retirement strategies and compel individuals to reconsider how they allocate and withdraw savings.
Double Taxation Explained: Inheritance and Income Taxes Combined
The new rules create the potential for a “double tax” scenario:
- Inheritance Tax (IHT): Any pension funds exceeding the £325,000 nil-rate band will face up to 40% tax.
- Income Tax: For beneficiaries inheriting pensions after the original holder’s death at or after age 75, the pension withdrawals will also be taxed at their marginal income tax rate.
For example:
- A £100,000 pension pot could be taxed at 40% IHT, leaving £60,000.
- If the beneficiary then pays 45% income tax on this amount, only £33,000 remains—an effective tax rate of 67%.
In extreme cases, including the loss of certain tax exemptions, this rate could soar to 90%.
Strategies to Mitigate Tax Liabilities
With the new regulations set to reshape retirement planning, proactive measures are essential. Consider the following strategies:
Rethink Retirement Drawdown Strategies
The traditional wisdom of using ISAs before pensions may no longer hold.
Spending down pensions during retirement instead of leaving them untouched can help reduce the estate value subject to IHT.
Gifting Assets
Using annual gift allowances or larger lifetime gifts can lower the taxable estate.
For instance, individuals can gift up to £3,000 annually without IHT implications.
Downsize Property
Selling a larger property and investing the proceeds into lower-value assets or distributing them among family members could reduce the taxable estate.
Consider Annuities
Purchasing an annuity transforms a lump sum into a guaranteed income, removing the pension pot from the estate.
Joint annuities allow for a surviving spouse to continue receiving income without IHT implications.
Life Insurance in Trust
Taking out a life insurance policy placed in trust can provide funds to cover the anticipated IHT liability, alleviating the financial burden on beneficiaries.
Why Act Now?
Although the changes will not take effect until 2027, acting early allows more flexibility in reshaping financial strategies.
There could also be further amendments or reversals to the policy, but preparing for the announced changes ensures financial resilience under any scenario.
Summary
The inclusion of pensions under IHT marks a transformative shift in retirement and estate planning.
To avoid leaving your family burdened with hefty tax bills, now is the time to review your financial strategy.
At Tax Expert, we specialise in helping you understand complex tax regulations and devise tailored strategies to protect your wealth.
Fill out our form here for any questions, give us a call at 01772 788200, or message us on our WhatsApp for out of office hours.
Kind regards,
Ilyas Patel