From 6 April 2027, significant changes to Inheritance Tax (IHT) rules are expected to come into effect. For many people, pensions have traditionally been an efficient way to pass wealth to loved ones, as defined contribution (personal or money purchase) pensions have generally sat outside of their estate for IHT purposes.
Under the planned changes, however, most unused defined contribution pension funds will be included as part of an individual’s estate when calculating any IHT liability. While this won’t affect everyone, it could mean that families who have never previously had to consider Inheritance Tax may suddenly find themselves facing a substantial tax bill.
The changes also highlight the importance of keeping retirement planning under review. For some people, it may present an opportunity to review how their assets are structured, whether their pensions remain suitable for their circumstances and whether there are legitimate ways to improve the position for future beneficiaries.
The following example illustrates how these changes could affect an ordinary family.
A practical example
George is aged 71, divorced, and his health is poor. He has a son, Kyle, and two grandchildren who are the beneficiaries of his will. Kyle is also the executor of the will.
George owns a two-bedroom house worth £240,000. He receives the full State Pension of £12,546 a year and two Final Salary Scheme pensions totalling £15,450 a year. This income comfortably covers his day-to-day expenditure, allowing him to save a little each month, particularly when he has success with his Premium Bonds, where he currently holds £50,000.
In addition, George has:
- £55,100 in a savings account
- £145,625 in a Stocks & Shares ISA
During his working life, George had several different employers, leaving him with five separate personal (defined contribution) pensions with a combined value of £309,275. His son, Kyle, is the nominated beneficiary on each of these pensions.
If George were to pass away before 6 April 2027, there would be no Inheritance Tax to pay on his estate. His non-pension assets total £490,725, which is below the combined available allowances of the £325,000 Nil Rate Band and the £175,000 Residence Nil Rate Band.
However, from 6 April 2027, the rules are changing so that the value of personal or money purchase pensions will be included within the value of an estate for IHT purposes. If George were to die after this date, his estate would increase significantly in value and Kyle could be faced with an Inheritance Tax bill of around £120,000, payable within six months.
Alongside the potential tax liability, Kyle would also need to contact and deal with five separate pension providers, gathering information and working through the administration for each pension while also managing the rest of his father’s estate.
Why reviewing your plans matters
George’s circumstances are not unusual. Many people have accumulated several pension pots throughout their working lives, alongside savings and investments built up over many years.
With the upcoming changes, now is a sensible time to review your financial arrangements and understand how your estate may be affected. Even if no action is ultimately required, knowing where you stand can provide valuable clarity for you and your family.
For some people, there may be opportunities to reduce or even eliminate a future IHT liability through appropriate financial planning. Others may benefit from consolidating multiple pension arrangements, making them easier to manage during retirement and reducing the administrative burden for loved ones in the future.
How Fogwill & Jones can help
Every family’s circumstances are different, which is why personalised advice is so important.
Our advisers can help people in George and Kyle’s situation by reviewing their overall financial position, exploring appropriate ways to reduce or eliminate a potential Inheritance Tax liability where possible, and assessing whether multiple personal pensions could be consolidated into a single arrangement to simplify administration.
With the proposed rule changes approaching, reviewing your plans now could help ensure your wealth is passed on as efficiently as possible and provide greater certainty for the people who matter most.