The 2024 Autumn Budget gave us the first notice (with little detail), with effect from 6 April 2027, most unused Pension Funds and Death Benefits would be, for the first time ever, brought within a deceased person’s estate for Inheritance Tax (“IHT”) purposes. Further details of the change can be found HERE.
The reason for the tax charge was to discourage the increased use and marketing of Pension Schemes as an IHT Tax Planning tool for the intergenerational transfer of wealth. More details have been released since the initial announcement, and individuals are starting to think about ways to mitigate the tax, or put their personal affairs in order, too aid executors and or administrator with death estate administration.
One of the main concerns with the change, is that the executors are responsible for completing the Tax Return and paying the tax liability. It may be difficult for executors to manage the process with HMRC’s lack of flexibility on the short six-month IHT payment deadline, when they must deal with finding the pension providers contact details, making contact, seeking the required authority and information.
We advise every year, as part of pre year end Corporate Planning and Tax Year End Planning, that individuals should consolidate scattered pension pots into one place, which now has more importance to prevent an administration nightmare for their families Pension consolidation makes sense outside of easing IHT administration, as consolidation should save fees and create a larger investment fund, which should generate an increased income in the future.
It is important that you take financial advice from a regulated advisor, to confirm consolidation is the best approach for those who are UK Tax Residents. An old pension scheme may have hefty cancellation fees, and/or if a Final Salary Scheme is involved, advice needs to be taken if these should be moved as part of the consolidation exercise. From a practical point of view, the individual needs to make sure that their family and/or executors have all the details they will need, either online or physically stored. This will help the Probate process and be invaluable for executors, hopefully reducing costs and the stress of the bereavement. It is always useful for the individual to make sure their executors know where important documentation is stored.
All of the documents should be physically stored in an accessible place where the executors will easily find them or know where to look. Alternatively, an electronic filing system that the executors know how to navigate may be preferable for copies of documents. Many providers do not provide hard copy documents anymore, the documents only being available via an online portal, which if the access details are not known, this will only slow the process.
With the move to bring pensions within the IHT regime, results in a review of your succession and wealth strategies. Historically and the reason for the change, for those individuals with both personal pensions and other investment assets, the IHT exempt status for pensions encouraged them to, where possible, finance their retirement spending from there non pension funds/assets which would be liable to IHT. Ringfencing the pension, as it is IHT free.
Now, with pensions coming within the scope of IHT, any planning advantage to passing on pension funds is gone. However, it should be noted that for those in Defined Contribution schemes who die before age 75, there is still a possibility that their beneficiaries could draw down funds (where the scheme allows), without an Income Tax charge. If you still hold both non-pension assets and funds in your pensions, then there may be scope to make Lifetime Transfers now, to reduce the likely IHT on your estate. Alternatively, recognising that pension beneficiaries may now receive less than you expected on your death, you may want to consider making additional provision for those beneficiaries in your Will. Provided you survive seven years, the gift of cash will be outside your estate of IHT purposes, known a potential exempt transfer (“PET”). Reduced rates of IHT apply if you survive 3 years after the date of the gift.
If you have not yet crystallised your pension, you might consider taking your 25% tax free lump sum from it. Making a gift of the cash withdrawn should again be a PET and IHT-free providing you survive 7 years.
Although the IHT benefits of Business and Agricultural Assets/Businesses have been reduced to £2.5m, with the extension of IHT to pensions, if there is scope to obtain some IHT relief outside the pension fund, you could explore the possibility of extracting any Business and Agricultural Property from your pension, or alternatively investing in assets qualifying for Business Relief. Most large investment providers have qualifying Business Relief products, and if £2.5m is invested, and you have no other Business or Agricultural assets, which is £2.5m exempt from IHT, for a husband and wife, this is £5m.
If you have excess income each year, you could make regular gifts out of that excess, which should be IHT exempt. This should be IHT free if structured correctly and does not have a survivorship time requirement. However, HMRC will require your executors to prove that you had surplus income and had planned to make regular gifts from it, therefore important to document these gifts and show why excess income.
Although regular withdrawals from a ‘drawdown’ pension will be subject to income tax, HMRC may not necessarily regard them as ‘income’ for the purposes of the IHT gifts out of income exemption. This is particularly true if they have been extracted specifically to fund a gift to your descendants. For example, your tax-free lump sum is unlikely to qualify as surplus income: such a gift would be treated as a potential exempt transfer.
However, if you have used your pension fund to buy an Annuity which provides you with a consistent source of income throughout your retirement, this should be considered income. If your Annuity income, together with other income from investments, is more than enough for your regular spending needs, gifting the surplus to family members could qualify for the gifts out of income exemption. Annuities provide a secure income stream, and any surplus income could then be gifted to your family using the ‘normal expenditure out of income’ allowance.
This change to Inheritance Tax on pensions is one of the most important shifts in estate planning in recent years. It brings pensions into line with other assets for tax purposes and will impact many families who had relied on them as a tax-free way to pass on wealth. While the new rules may feel like a blow, there are still several ways to plan effectively, but must look at this now. Whether it is exploring Annuities, considering insurance, or using income to support family gifts, there are strategies available that could be considered.
Outside of the change to pension, IHT collection by HMRC is on the increase, not only because more taxpayers are being caught within the net, and rule changes, but the increase in the number of enquiries. The Treasury see IHT has a growth revenue, receipts for March 2026 were £775 million, up from £614m in February and from £671m March 2025. Further details and other IHT planning strategies can be found HERE.
Please note that Harbour Key are not financial advisors and are unable to provide financial advice.
