Pensions and Estate Planning: Adapting to New Tax Rules from April 2027
The Autumn 2024 Budget introduced significant changes that will impact how pensions are handled for inheritance tax (IHT) purposes. Starting 6 April 2027, unused pension funds and death benefits will be included in a person’s estate for IHT, representing a crucial shift in the role pensions play in estate planning.
This change follows a comprehensive consultation and feedback process, with HMRC announcing their final decision to proceed with the inclusion of pensions in the IHT net. As a result, personal representatives (PRs), rather than pension scheme administrators (PSAs), will be responsible for handling the reporting and payment of IHT on pensions. This adjustment marks a fundamental shift in how estates will manage pension benefits and requires careful rethinking of asset distribution during the decumulation phase of a financial journey.
Reassessing the Decumulation Strategy
For many, the traditional approach of “touch pensions last” in estate planning was based on the benefit of IHT relief. However, this strategy will no longer hold after April 2027. With pensions now subject to IHT, there will be a need to reconsider how assets are accessed in the decumulation phase to ensure wealth is efficiently managed and taxed.
From the outset, the order in which assets are accessed—whether pensions, ISAs, or investment accounts—becomes critical in optimizing both tax efficiency and estate planning goals. While pension scheme administrators will still play a key role, under the new rules, they are required to pay IHT directly from the pension fund upon request, as long as the fund balance is sufficient and the IHT liability exceeds £4,000. This shift aligns pensions with the broader estate settlement process and eliminates the need for bespoke pension scheme rules. In practice, this simplifies the process but introduces new considerations around which assets should be accessed first.
The Accumulation Phase: A More Diverse Approach
In addition to the decumulation phase, these changes will also impact the accumulation phase of wealth-building. With pensions no longer the primary vehicle for IHT planning, there may be a move to diversify wealth-building strategies. Rather than focusing solely on pension contributions, attention may shift towards ISAs, investments, and other structures that offer both tax efficiency and flexibility.
Given the shift in pension taxation, understanding the broader landscape of asset classes becomes more important. This may involve weighing the benefits of tax-free growth in ISAs or other flexible investment vehicles that do not attract IHT, alongside pensions that will now be fully exposed to inheritance tax.
Navigating Complexities in Estate Settlement
The updated approach to IHT on pensions will require careful attention to the order of asset distribution in the decumulation phase. The responsibility of PRs for paying IHT on pensions could lead to complications, particularly where the beneficiaries of the pension do not match those inheriting the estate. This dynamic will demand a clearer understanding of how pensions, alongside other assets, should be structured and withdrawn to avoid unnecessary complications.
It’s important to keep in mind that, under the new system, if IHT is paid from the pension fund, the remaining death benefits could be subject to income tax if the member passed away after the age of 75. This layer of complexity will require strategic planning to manage the combination of both IHT and income tax liabilities effectively.
Strategic Estate Planning Moving Forward
As we approach 2027, the inclusion of pensions in IHT highlights the need for more integrated estate planning. The evolving tax landscape will require careful consideration when deciding the order in which to access assets, as well as how to best structure wealth over time. A diversified approach to saving and investment will be crucial in mitigating the impact of IHT, particularly where pensions may no longer serve as the go-to asset for estate planning.
Estate planning is becoming increasingly nuanced, requiring careful coordination between the different asset classes within a family’s wealth. By thoughtfully structuring pensions alongside other investments and savings, it is possible to ensure that estate plans are in line with both long-term financial goals and the changing tax rules.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
The Financial Conduct Authority does not regulate Inheritance Tax Planning, Estate Planning & Trust Planning. The value of tax benefits described depend on your individual circumstances. Tax rules can change.