Following the inheritance tax seminar we hosted in September, our October Spotlight Report focuses on one of the most significant upcoming changes to inheritance tax (IHT): the inclusion of pension funds within an individual’s estate from April 2027.
From 6 April 2027, most defined contribution pension schemes, including personal pensions, SIPPs and the majority of workplace pensions, will form part of an individual’s estate for IHT purposes. This may include any funds remaining within the scheme on death, as well as most lump sum death benefits, although some notable exceptions remain.
At the same time, the inheritance tax nil-rate band and residence nil-rate band are set to remain frozen until April 2031. As asset values continue to rise, more estates are likely to become subject to IHT, and existing liabilities could increase significantly.
The risk of double taxation
It is also important to consider the interaction between inheritance tax and income tax.
Where the deceased dies after age 75, beneficiaries may be required to pay income tax on pension withdrawals. Combined with the new IHT charge, pension funds could effectively be taxed twice. In some circumstances, this could result in an overall effective tax rate of up to 64%.
So, what can be done. For many years, conventional wisdom has been to preserve pension funds and instead spend other assets that would otherwise form part of the taxable estate. From April 2027, this may no longer be the most effective strategy.
Individuals may wish to consider drawing tax-free lump sums from their pensions and making gifts during their lifetime. Existing inheritance tax reliefs remain available, including the annual £3000 exemption, s.21 gifts (out of regular income) and potentially exempt transfers.
Plans built around the old rules might no longer achieve the desired effect, and could end up with a significant tax liability. It is important to review your position before April 2027.
If you would like advice on how these changes may affect you or your family, please contact us to discuss your circumstances.
