Inheritance Tax and pensions: Why you may need to rethink your estate plan

In her inaugural Autumn Budget, at the end of October 2024, Rachel Reeves announced a proposal to make pension pots liable to Inheritance Tax (IHT).

Although the government consultation closed on 22 January 2025, the final report is yet to be published. HMRC’s website simply refers to the publication as being available “later in the year”. We will let you know when details are released.

With complex issues surrounding how and when to introduce such changes, there is still much to understand.

However, as we wait for the government to finalise and confirm the changes, it may be wise to revisit your estate plan. Acting now could help to ensure that more of your hard-earned wealth can be passed to your beneficiaries without being eroded by IHT.

The proposed rule change in a nutshell

From April 2027, the “loophole” allowing you to leave unused pension savings to beneficiaries without paying IHT is expected to be removed.

As such, from April 2027, if you leave pension funds to beneficiaries, those assets may be subject to IHT.

According to a report from PensionsAge, this change could affect more than 150,000 estates. If yours is among them, there’s time to act before the changes come into force.

The existing Inheritance Tax thresholds remain unchanged and are frozen until April 2030

The nil-rate band remains fixed at £325,000 and the residence nil-rate band continues at £175,000, if you pass your main residence to your direct descendants, such as your children or grandchildren.

Combined, these thresholds allow you to pass up to £500,000 to beneficiaries tax-free.

In 2024/25, the standard IHT rate is 40%, and only applies to the portion of your estate that exceeds these thresholds.

Practical ways you could protect your legacy in light of the proposed changes

If your estate is likely to be subject to IHT, and you suspect the proposed changes may further erode your estate, the simple solution may be to increase your retirement income and spend it while there’s time.

You may wish to take more holidays, splash out on some home improvements to make your daily life more comfortable, or upgrade your car to make getting from A to B more enjoyable.

Alternatively, you could share your wealth with your beneficiaries while you’re still around to see your family and loved ones enjoy greater financial security.

Here’s a reminder of the methods you gift your wealth to others before your death.

Make the most of the current Inheritance Tax gifting rules

Everyone can make multiple IHT-free gifts every year. In 2024/25, you can:

• • Gift up to £3,000 a year using your annual exemption – any unused amount can be carried forward and used in the next tax year
  • Give wedding gifts – £5,000 for a child who is getting married, £2,500 for a grandchild, and £1,000 for any other person you know who’s getting married.
  • Give small gifts of up to £250 – you can gift this to anyone you know each year, although not to someone who has benefited from your £3,000 exempt amount.

It is, of course, possible to gift over and above these annual gifting allowances. And, provided you live for seven years or more after making the gift, the wealth you give away will fall outside of the value of the estate.

This is called a “potentially exempt transfer” or PET.

If you die within seven years of making a PET, taper relief rules may apply. It is a common misunderstanding that that the taper relief applies to all gifts that fail the seven years rule. However, it is only relevant if the failed gifts have already exceeded an individual’s nil rate band allowance (£325,000).

Where there have been multiple gifts they will use the nil rate band in chronological order with the earliest transfer having first use of the nil rate band.

While there is no further IHT on chargeable transfers which fall within the nil rate band it will mean there is less nil rate band available to use against the deceased’s estate. This will mean that IHT may become payable at 40% on other assets within the estate.

Where relevant, the amount of IHT applied will depend on how soon you die after making your gift:

A careful and strategic approach using gifts and PETs could allow you to transfer more of your wealth to your chosen beneficiaries during your lifetime.

Consider increasing the pension income you draw and use it to make regular financial gifts

The “gifting through income” rule allows you to pass extra funds to your loved ones on a regular basis.

To effect this, you could increase the amount of money you withdraw from your pension to boost your income and have more on hand to share with someone else, or multiple people.

You make regular gifts to:

• • Contribute to a savings account, ISA, or pension for children or grandchildren
  • Support loved ones by helping to cover household costs
  • Provide extra financial support to an elderly relative.

To be sure these financial gifts remain free of IHT, you need to stick to certain rules. Payments should be:

• • Made regularly
  • Paid from your regular monthly income, not capital
  • Affordable without detriment to your own standard of living.

Ultimately, it’s crucial that gifts from income are considered part of your normal expenditure.

Plus, you’ll need to show a pattern of payments over an extended period of time – HMRC typically look back at the past three to four years to see how often you made payments.

Unlike other gifting rules, gifts from income fall outside your estate with immediate effect and aren’t subject to the seven-year rule.

Leave your pension to your spouse

Finally, regardless of whether you’re doing any of the above, leaving your pension to your spouse or civil partner will also help your pension savings remain free of IHT.

A final reminder to complete or review your expression of wish

Your pension isn’t covered by your will. Instead, you must complete an “expression of wish” form with your pension provider.

If you’ve already completed this, good stuff – but it’s wise to revisit this form and ensure it continues to reflect your intent.

If you’ve been a member of several pension schemes over the course of your career, you may need to keep track of multiple expression of wish forms. So, be sure to be methodical so you can rest easy, knowing that everything is in order.

Get in touch

If you’d like to explore steps you could take to protect your wealth and mitigate a potential IHT charge on your estate, please get in touch.

Using sophisticated cashflow modelling software, we can help you visualise how much wealth you can comfortably spend or gift, while still ensuring a sustainable income throughout your retirement.

Email us at info@harperlees.co.uk or call 01277 350560 and we’ll be very happy to help.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning, tax planning, or cashflow planning.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.

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. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

Workplace pensions are regulated by The Pension Regulator.