Whilst we could continue to put our heads in the sand and hope it goes away, the fact is that the inclusion of Defined Contribution (DC) pension accounts in taxable estates for Inheritance Tax (IHT) purposes seems to be going ahead as planned.
As a reminder, this change was introduced in the Autumn 2024 budget and will come into effect in April 2027, meaning that any remaining funds in your hard-earned pension may now be subject to a 40% levy on your death.
This move will also tip many people over the tax-free threshold – known as the Nil Rate Band (NRB), currently £325,000 per person – and create a tax liability where they may not have had one before. If you are passing on property under a certain value to a direct family member, the Residence Nil Rate Band (RNRB) will bump your tax-free allowance up to £500,000 (£1 million per couple).
So, what can we do about it? Here are four things you can start with.
1. Review your expression of wishes on death benefits
If you made your expression of wishes before the changes were announced, you may well have an arrangement which parcels out your pension funds among your family members. Whilst pensions have been a great IHT-free asset for a long time, this is unfortunately no longer the case, and you will need to be shrewd about how the funds pass on.
For example, if you have already made other gifts to your children or grandchildren that haven’t yet fallen outside of your estate as per the seven-year rule, the additional bequest of the pension funds may affect your available NRB and attract an IHT charge.
On the other hand, you can pass on assets to a surviving spouse with no immediate tax liability – your NRB rolls over to them, too. With this in mind, it may be appropriate to revisit your expression of wishes and channel the funds to them instead. Always consult your wealth manager before adjusting your gifting or estate plan.
2. Look at a plan to empty your pension account before death
Passing pensions on a generation after death used to be quite tax efficient, but from April 2027 it becomes very tax inefficient if you are over 75, with beneficiaries liable to both IHT and Income Tax to access the money.
Therefore, planning to deplete your pension before it needs to be passed on may work favourably. This doesn’t mean spending the whole lot, necessarily – a carefully planned income strategy will make provision for funnelling some of your withdrawals into more tax-efficient wrappers and accounts that can be more easily gifted or passed on.
This second point leads to two further considerations:
3. Review your pension account investments
Depleting your pension early means higher withdrawal amounts, which requires your investment accounts to cash capital over time. This requires a completely different investment strategy to an account that will be added to and not touched for many years.
Riskier assets with higher return potential are better held outside a pension fund. Imagine how galling it would be if a high-risk investment inside the pension account does well, but IHT and income tax mean that beneficiaries end up paying away 60% of the profit made.
Hold such an investment where the ultimate tax will be lower.
4. Have an alternative plan for late life financial security
As mentioned, if we want to avoid IHT on pension funds, that will often mean exhausting the account before we die. But if the pension is no longer there to support us, then we need a Plan B for income.
This could be ISA money which will only get taxed once, or even better, equity release if it’s 40% tax deductible! If you haven’t already taken your tax-free lump sum, you could even consider using it to open an Offshore Bond, which offers a unique raft of benefits and opportunities around tax efficiency and inheritance tax planning. You can learn more about this here.
What next?
If you haven’t revisited your pension drawdown strategy since the pensions and IHT announcement, it’s probably worth a few minutes of your time.
Get in touch if you’d like to chat through your current pension strategy and see where you could make adjustments.
Give us a call on 020 3143 6100 or fill in the form below and we’ll get in touch as soon as possible.
