Pensions and Inheritance Tax (IHT): What’s the Deal?Written on January 13, 2025 by Kirk Rice LLP
After years of flying under the IHT radar, the Chancellor has decided it’s time for pensions to join the inheritance tax (IHT) club.
The Current Landscape: Pretty Tax-Efficient
Since 2015, pensions have become a cornerstone of inheritance tax (IHT) planning. Why? Because they’re typically excluded from your taxable estate. In simple terms, pension death benefits often bypass the 40% IHT charge, making them a powerful tool for passing on wealth efficiently. Here’s how it works today:
- Under 75? Your beneficiaries inherit the pension tax-free. No IHT, no income tax.
- Over 75? Still no IHT, but the funds are subject to income tax at your beneficiary’s marginal rate.
The current government feels some people have been using this setup as a clever workaround to minimise inheritance tax bills. And when there’s a perceived “loophole,” a consultation usually isn’t far behind.
What’s Changing in 2027?
From 6th April 2027, unused pension funds passed to beneficiaries will become part of the deceased’s estate for IHT purposes. Here’s an example of the proposed changes:
- Inheritance Tax Will Apply: Any leftover pension funds will count towards the estate, taxed at the usual 40% over the £325,000 threshold.
- Defined Contribution Schemes Are in the Hot Seat: These are more likely to be affected, as they often leave substantial lump sums behind.
How This Could Look in Practice
Let’s say Sally, age 73, has no spouse and a £1.6 million estate, split evenly between her Defined Contribution pension (£800,000) and her remaining estate (£800,000).
Before 6 April 2027
- (Pension) £800,000: Not part of her estate, no IHT
- (Estate) £800,000: Subject to IHT
- (Estate) £800,000 – £325,000 (Threshold) = £475,000
- £475,000 x 40% = £190,000 IHT bill
After 6 April 2027
- Total taxable estate: £1,600,000 (Pension £800,000 + Estate £800,000)
- £1,600,000 – £325,000 (Threshold) = £1,275,000
- £1,275,000 x 40% = £510,000 IHT bill
That’s more than double the tax, with the burden split between the pension and the rest of her estate.
Doubling Down on IHT & Pensions
If you’re 75 or older when you pass away, your loved ones could face not one but two taxes on your pension: IHT and income tax. The age rules for income tax on pensions remain:
- Under 75: inherited pensions escape income tax (but not IHT).
- 75 or older: pensions get hit with income tax at the recipient’s personal rate (on top of IHT).
What Should You Do?
How we pass on wealth to those we care about is changing. If you haven’t started planning yet, don’t worry—there’s still time to act. Our team are happy to review your estate planning strategies. Email us at info@kirkrice.co.uk to arrange a meeting, the first is free of charge.
Please note: This article is correct as at the publication date. The answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made. The information is based on current tax legislation which may change in future. Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of relief from taxation are subject to change. The Financial Conduct Authority does not regulate tax planning.
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