Pensions and Inheritance Tax: What the new rules could mean for you and your executors

Historically, pensions have been a relatively simple aspect of estate planning. As they did not form part of the estate for Inheritance Tax (IHT) purposes, they were often seen as a tax-efficient means of passing on wealth.

However, in the Autumn 2024 Budget, the chancellor announced that from 6 April 2027, unused pension funds and death benefits would be included in an estate and therefore be in the scope of IHT.

This has meant a new approach for estate planning, as well as increased responsibilities for executors.

Read on to find out more about the changes, what they could mean for you, and the new onus on executors.

New rules will see an increased number of estates liable to pay Inheritance Tax

First, it can be useful to have a reminder of the thresholds, rates, and exemptions attached to IHT.

• • You won’t usually pay IHT on any portion of your estate up to the nil-rate band of £325,000.
  • You may benefit from up to £175,000 residence nil-rate band if you leave your home to your direct descendants, such as children or grandchildren. This potentially brings the total IHT-free threshold to £500,000.
  • You can leave your entire estate to a spouse, civil partner, or charity without IHT.
  • Any unused nil-rate bands can be added to your spouse or civil partner’s threshold when you die.
  • IHT is usually applied at 40% on any wealth that exceeds the nil-rate bands, but this could be reduced to 36% if you leave 10% or more of your estate’s value to charity.
  • These thresholds are currently frozen until April 2031.

Including pensions in an estate could raise its value above the threshold, meaning more estates may be liable for IHT, or could pay more than they previously would have.

According to the government, the new rules are expected to see:

• • 10,500 estates having an IHT liability where they previously would not
  • 38,500 estates paying more IHT than previously
  • An average increase of £34,000 in IHT liability.

This means that your estate planning strategy may need to change if it’s likely that inclusion of a pension will push you over the threshold.

There are some measures you could take to protect your loved ones from an increased liability, including:

Gifting to charity

If you leave at least 10% of your estate to a UK-registered charity in your will, then the rate of IHT can drop from 40% to 36%.

This is also a good way to support an important cause or remember a charity which has been close to your heart, benefiting both them and your loved ones in the process.

However, depending on the size of your estate, leaving 10% of your wealth to charity could mean your beneficiaries receive less than they would have done, despite the reduced rate of IHT. That’s why it’s important to seek professional advice when creating an estate plan.

Making full use of your allowances

You have several annual allowances for gifts that immediately become free from IHT:

• • You can gift £3,000 a year, and can also carry forward one year’s unused allowance.
  • Wedding gifts of £500 from parents, £2,500 from grandparents, and £1,000 from others are also exempt from IHT.
  • Small gifts of up to £250 can be made to as many people as you like.

Potentially exempt transfer (PET)

This applies to gifts that exceed the allowances described above. If you live for seven years after making the gift, it becomes exempt from IHT. However, if you die within three years, the amount will be added back into your estate and will be included for IHT liability.

Taper relief applies if you die between three and seven years after you make the gift, reducing the rate of IHT payable on the gift incrementally.

Gifting from surplus income

This money must come from your regular income, and not be to the detriment of your usual lifestyle and standard of living.

There also needs to be a set pattern to the gifting, such as monthly or annual payments. As long as the criteria are met, you can make unlimited payments that are exempt from IHT.

Life insurance

While this option won’t reduce your assets below the IHT threshold, it could help your loved ones to meet a potential IHT bill. Taking out life insurance for the amount you expect your IHT to be, and writing it into trust, means that the policy payout will be outside the remit of your estate.

While the above can be considerations, there is no one-size-fits-all approach, as every individual and family’s circumstances are unique. We strongly recommend you take financial advice to find the approach which could work best for you.

Executors and administrators will have increased responsibilities from 2027

Your estate is administered by your appointed executor, or if you die without a will, by an administrator chosen by the courts. The new rules will see something of a seismic shift in their responsibilities.

From 2027, executors and administrators must:

• • Work closely with pension providers to identify and obtain valuations for all private pension arrangements
  • Report these to HMRC
  • Ensure that any IHT on these funds is paid
  • As pension funds are often only released after probate, and IHT is usually required to be paid before probate is settled, this could create a liquidity issue. In these cases, executors will have the authority to request that pension fund administrators can pay IHT before releasing remaining funds.

Important to note is that executors can also be held personally liable for any IHT shortfall or penalty payments.

We strongly advise that you obtain permission before naming an executor for your will. If you don’t, they could refuse the role.

With these new responsibilities coming into force, it is important that you appoint an executor you believe will be able to handle the role, and that they feel well-informed and comfortable about the remit of these expectations.

Get in touch

Estate planning is complex, and with the new rules surrounding pensions and executors, it is only set to become even more so.

We’ve outlined some potential ideas for keeping IHT to a minimum, but circumstances can vary so much that it’s important to seek advice before putting anything in place.

There is no ‘one size fits all’ solution to decide the right way forward. For some individuals, withdrawals to fund gifts may be a sensible plan, however, care should be taken to ensure money is not needed for now, or for later.

The worst possible outcome is likely to be a knee-jerk reaction to drawing benefits from your pension to attempt to mitigate the IHT changes. Pensions will still provide the valuable tax advantages of no tax on gains or income, despite being pulled into the IHT net.

Please email us at info@harperlees.co.uk or call 01277 350560 to find out more, 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 individuals only.

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

The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or will writing.

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.