In April 2027, some key pension changes are set to come into force. Under certain circumstances, unused pension funds may be included in the deceased’s estate for IHT purposes. HMRC is still refining the rules, but the direction of travel is clear.
These changes have raised a key question: “Will pensions still be a tax-efficient way to pass on wealth?” At Tandem, our short answer is yes, but certain individuals may need to pivot their financial plan to protect their wealth and goals.
Let’s take a closer look at the proposed pension changes and what your options are.
Pensions – the end of an era
For a long time, pension “pots” (defined contribution – or DC – pensions) have been a favourable vehicle for retirement planning.
Firstly, they offer tax relief on your contributions. If you are a basic rate taxpayer, it effectively “costs” you 80p to put £1 into your pension. For those on the higher and additional rates, the tax relief is 40% and 45%, respectively. In simple terms, the money that would have gone to HMRC goes into your pension instead.
Secondly, pensions offer a “wrapper” to protect your investments from dividend tax, capital gains tax (CGT) and tax on interest. Once you reach your Normal Minimum Pension Age (NMPA – i.e. currently 55, but rising to 57 in 2028), up to £268,275 can be withdrawn from your pensions with no income tax liability.
A third advantage of DC pensions (now outgoing) is that they have enjoyed quite a generous tax status when it comes to inheritance. However, this is now set to change.
What’s changing from April 2027?
If you die before age 75, your beneficiaries can typically inherit your pension pot without paying income tax. If you die after 75, they pay income tax at their marginal rate.
This rule will stay the same.
However, from 6th April 2027, pensions will no longer be exempt from someone’s taxable estate in all cases. If you die after this date, your unused DC funds could face IHT.
Multiple reasons have been offered for this change. HMRC seems to believe the 2015 Pension Freedoms have inadvertently turned pensions into de facto inheritance vehicles. Ultimately, however, a key driver is the UK government seeking more money for its coffers.
Recent data shows the UK’s public finances in a difficult state. The country is facing challenges related to debt, economic growth and public spending. The thinking is: perhaps pension wealth could unlock some much-needed revenue to balance the books?
The implications for pension planning
These changes, while not seismic, do alter the landscape of retirement and estate planning. Here are the practical implications:
- Early pension use may become more commonplace. Until now, advisers have often suggested financing early retirement from non-pension income sources (e.g. ISAs, which cannot typically be passed down IHT-free). With pensions soon potentially exposed to IHT after death, this incentive decreases.
- Reviewing death benefit nominations will be crucial. As mentioned, the new rules are still being ironed out by HMRC. To protect your estate, make it a priority to ensure that your Expression of Wish forms are up to date.
- Defined benefit (DB) schemes become more attractive. Already widely known as “gold-plated” pensions, the case for transferring out of these schemes will likely become weaker after 6 April 2027. Very few employers still offer these types of pension other than the civil service, local authorities or the NHS. The proposed changes are not targeted at DB pensions, which typically do not offer large transferable lump sums at death (and any survivor’s pension is already taxed under PAYE rules).
- Estate planning is likely to become more complex. Clients with multiple asset classes (e.g. ISAs, general investment accounts, property and pensions) will likely need more nuanced advice to optimise drawdown strategies, tax liabilities and legacy planning. The sequencing of withdrawals becomes even more critical.
What can you do now?
2027 may still feel like a long way off. However, planning ahead could save you some major headaches later. In particular, if your plan currently involves preserving your pension pot until late in life, it may be time to talk to a financial adviser.
With pension pots possibly falling into your estate after 2027, it may be appropriate to focus your estate plan toward other tax-efficient ways of passing down wealth.
For instance, utilising your annual gift allowance or making potentially exempt transfers (PETs) could become more important. Use of Investment bonds (onshore or offshore) into Trusts is also a great option to mitigate inheritance tax. This form of planning is more in depth and requires advice for sure to do speak to your adviser if you wish to know more.
Passing pensions to a spouse or civil partner will likely remain highly tax efficient. If you die and leave everything to your better half, they can still receive your assets without IHT (pre or post age 75 but post 75 the benefits are taxable at the recipient’s marginal rate for income tax). You might also explore Spousal Bypass Trusts (or Asset Preservation Trusts) but speak to an adviser about this (their treatment under the new rules remains under review).
In closing, consider engaging in periodic reviews with your adviser if you are not already doing so. Tax legislation is always shifting, and keeping an ongoing dialogue will help you adapt to changes promptly and efficiently.
If you are yet to do so, we invite you to experience the Tandem difference for retirement and estate planning.
For those we currently serve, I hope these thoughts have helped and inspired you.
Until next time!
Related Posts
