Despite strong pushback from the industry, many families will face inheritance tax as the government moves forward with its pension changes. Starting in April 2027, pension pots will be counted towards the overall property value for tax purposes. This shift was first announced last October, prompting hundreds of pension firms, financial advisors, and tax experts to raise concerns.
Andrew Tully from investment firm Nucleus described the situation as troubling. “Many grieving families will not only face heavier taxes but also navigate a maze of paperwork,” he noted, emphasizing that this issue affects not just the wealthy but also the middle class. With rising asset prices and a frozen threshold, the burden of inheritance tax is likely to increase for many.
Assets left to a spouse or civil partner, as well as those in pensions dated after 2027, will still be exempt from this tax. Couples can share unused allowances and pass up to £1 million without tax consequences.
Red Tape Burden
The new regulations will require “individual representatives” to handle affairs with HM Revenue & Customs (HMRC) regarding inheritance tax tied to pensions. Typically, this will be the executor of the will—usually a family member or attorney.
These representatives will need to track down all pension pots belonging to the deceased, contact the respective companies, and assess their value on the date of death. Afterward, they’ll need to calculate tax obligations and coordinate with the pension beneficiaries on how the tax should be addressed, determining whether it will be settled through property, pension, or the pension company itself.
All of this must be completed within six months after death. Some advocates are urging the government to extend this deadline to 12 or even 24 months, citing the added complexities that pensions introduce.
Rachel Vahey from AJ Bell stated that the entire process can be quite convoluted. Pension firms may retain as much as 40% of the pension’s value until they confirm tax obligations are settled, which could lead to significant delays for families awaiting funds.
Higher Taxes
Currently, most people inheriting pensions, including spouses and civil partners, will incur income tax on those funds, but only if the pension owner passes away before turning 75. The government has assured that this will remain unchanged even after the inheritance tax implications come into play.
For instance, a higher taxpayer inheriting a £100,000 pension from a £600,000 estate would lose £40,000 to inheritance tax, leaving £60,000. If this sum is subject to a 40% income tax, an additional £24,000 would go to HMRC, resulting in only £36,000 for the heir. In the case of top taxpayers, their total tax burden could reach 67% or more.
If pension assets surpass £2 million, the overall tax burden on inherited pensions could escalate to 90% due to numerous expenses and high income tax brackets.
Double Hit Rate
Last year, about 5% of estates paid inheritance tax, and forecasts indicate that this figure could rise to 10% by 2030 because of the pension rules. The amount of inheritance tax collected is projected to jump from £8.4 billion by the end of this fiscal year to £14.3 billion over the next decade.
Pension assets alone are expected to contribute around £1.5 billion annually. However, consultancy LCP believes this estimate may significantly underplay the full effects of the tax changes, predicting that pensions could generate as much as £3 billion each year in inheritance tax revenue.
One factor driving these numbers is that many savers are shifting from traditional defined benefit pensions to defined contribution plans, offering more flexibility but with less retirement certainty. Since 2015, over 100,000 pension pots have been transferred and are subject to these new tax rules.
What You Can Do
Financial advisors are already witnessing increased demand for property planning solutions like insurance contracts and trusts, as families look to safeguard their heirs while managing tax responsibilities.
One approach is life insurance that covers anticipated inheritance taxes, placed in a trust to keep insurance payments outside the estate. “Clients are considering life insurance policies written into trusts to cover IHT costs,” explained Lucy Spencer, a wealth manager at Evelyn. “This way, funds are available to settle those tax bills without needing to sell assets or take out loans.”
Wealth management firm St James Place (SJP) hopes to see more people utilizing a policy known as Gift Intervivos Insurance, which is designed specifically to cover inheritance tax on gifts made before one’s death. If the gifter lives for another seven years after making the gift, it won’t impact the tax value of that gift; however, should they pass away sooner, the beneficiary could find themselves liable for the tax.
According to SJP’s Tony Mudd, interest in such financial products has doubled over the past year.
Bryony Cove from the law firm Farrer & Co underscored the complexity of the system, advising that individuals seek guidance from experienced professionals to navigate these challenges properly.
The Ministry of Finance has reiterated its encouragement for pension savings to be used for their intended purpose instead of as a way to transfer wealth. They claim that more than 90% of estates will remain exempt from inheritance tax following these and related changes.
