Inheritance Tax: Changes to the Rules on Pensions from 2027

Posted
AuthorIsabel Harding-James

At the Autumn Budget 2024, the Government announced their plans to include most unused pension funds and death benefits within the value of a person’s estate for Inheritance Tax (“IHT”) purposes from 6^th April 2027.

Following a technical consultation, the Government have since confirmed that the changes will be implemented as well as publishing draft legislation.

Key Takeaways:

From 6^th April 2027, most unused pension funds will count towards your estate for IHT which could push more estates over the IHT threshold.
Death in service benefits from non-discretionary and discretionary schemes will not be subject to IHT.
If your estate (including pensions) is near or over the IHT threshold even with the available IHT allowances, it may be worth considering estate planning advice.

What is the current position?

Currently, most unused pension funds are not included within a deceased person’s estate for IHT.

This is due to many UK registered pension schemes being discretionary where the Trustees of the scheme have discretion in deciding who receives any unused funds and benefits when the pension holder dies (death benefits), even where the pension holder has nominated who they would like to receive any such death benefits.

What is changing? How will this work?

From 6^th April 2027, most unused pension funds and death benefits will be included when valuing a deceased person’s estate for IHT.

The Government’s response to the technical consultation has confirmed that Personal Representatives (“PRs”) (executors or administrators) will be responsible for valuing the deceased’s estate for IHT, reporting to HMRC, and paying any IHT on unused pension funds and death benefits. Originally, the Government’s proposal was for the Pension Scheme Administrator (“PSA”) to be responsible for this, however, following the technical consultation where concerns were raised over the practicalities and timescales of this, the Government confirmed that they would not proceed with the PSA-led process.

The Government’s response also illustrated the process for how this will work in practice and is summarised briefly below:

Stage 1: Information Exchange

PRs will inform the PSAs of the pension holder’s death.
PSAs will tell the PRs the value of the deceased’s pension for IHT purposes, including how the pension benefits will be split between exempt beneficiaries for IHT (for example, spouses and civil partners) and non-exempt beneficiaries.

Stage 2: Valuation

PRs will value the estate for IHT, including the pension’s value and the value of other components of the estate (for example, property, bank accounts, investments etc.).

Stage 3: Submitting the IHT account and paying IHT, if necessary

If no IHT account is needed > PRs will inform the PSAs and proceed with the probate application and estate administration.
If an IHT account is needed but there is no IHT > PRs will submit the IHT account and can then proceed with the probate application and estate administration.
If an IHT account is needed and there is IHT > PRs will submit the IHT account and inform the PSAs of the amount of IHT due on the pension.

Stage 4: Distributing pension benefits

PSAs will inform the pension beneficiaries of their inheritance.
For non-exempt beneficiaries, PSAs will explain that IHT may be due.

Stage 5: Amendments

PRs will be responsible for submitting any amended IHT accounts to HMRC.
If amendments result in more IHT being due > PRs will inform the pension beneficiaries.
If amendments result in less IHT being due > PRs will be responsible for distributing the refund to beneficiaries.

Why are the rules changing?

The Government’s view, as highlighted in the Autumn Budget 2024 policy paper and the consultation, is that pensions have increasingly become an IHT planning tool to transfer wealth on death in a tax-efficient way, instead of being used for the intended purpose of funding a person’s retirement. The changes, the Government, say are to remove this incentive.

In addition to this, the Government sees the changes as a way to ensure consistency in how discretionary and non-discretionary pension schemes are treated for IHT purposes. Currently, undrawn funds from non-discretionary pension schemes, for instance, the NHS, are already included as part of a person’s estate for IHT purposes.

What will be the impact of the changes?

The Government estimates that in 2027-2028, 10,500 out of around 213,000 estates with inheritable pension wealth will have to pay IHT due to the changes, and around 38,500 estates will have to pay more IHT than they would have previously.

The inclusion of unused pension funds and death benefits will increase the size of people’s estates which may affect the availability of the IHT allowance called the Residence Nil Rate Band (“RNRB”). The RNRB is available where the deceased has left their home to their children or lineal descendants, however, the allowance reduces for estates which exceed £2 million.

What about death in service benefits?

Under the current rules, only death in service benefits paid from a non-discretionary pension scheme or trust are subject to IHT. The Government’s original proposal was that all lump sum death in service benefits would be subject to IHT, however, the Government’s response to the technical consultation has now confirmed that all death in service benefits will not be subject to IHT, regardless of whether the scheme is discretionary or non-discretionary, to provide consistency.

Moving forward

The Government’s response to the technical consultation confirms that they will continue to work with industry experts to refine and develop the process, as well as providing further guidance and tools ahead of 6^th April 2027.

Here to Support You

If you would like to discuss estate planning in light of the upcoming changes, then please don’t hesitate to reach out to our team of legal experts at John Hodge Solicitors, conveniently located throughout the South West, with offices in Bridgwater, Bristol, Clevedon, Wedmore, Weston-super-Mare and Yatton.

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