In the Autumn Budget, Rachel Reeves announced a proposal for unused pension funds and death benefits to become subject to Inheritance Tax (IHT) from April 2027.
The consultation period for this widely unpopular proposition closed on 22 January, but results of this won’t be revealed until “later in the year”.
With the Office for Budget Responsibility estimating that more than 150,000 estates will be affected by the change, your clients may be among them.
If you or your clients have an estate plan that includes the use of pension funds to help mitigate IHT, we can help. Get in touch to find out more, or read on to find out what the changes mean and a few options that could be useful should clients need a rethink.
A brief overview of the Inheritance Tax thresholds
A 40% IHT charge is applied to an estate if it exceeds the following tax-free thresholds:
- £325,000 for most estates
- £500,000 when passing a home to children or grandchildren (if the estate is under £2 million)
- Anything left to a spouse or civil partner can be passed free of IHT.
These thresholds have been frozen and aren’t expected to change before 2030.
From April 2027, if an estate exceeds the tax-free thresholds, any unused pension savings will be included in IHT calculations.
3 practical ways to address a potential Inheritance Tax problem
Fortunately, there are some useful allowances and exemptions that can be used to help reduce an IHT liability.
Here are three possibilities that could be considered.
1. Make the most of gifting rules
Every individual has a a variety of IHT-free gifting options every year. In 2024/25, these include:
- An annual exemption of £3,000 – any unused amount can be carried forward and used in the next tax year
- Wedding gifts – up to £5,000 for a child, £2,500 for a grandchild, and £1,000 for any other person you know who’s getting married
- Small gift allowance of £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 any amount over and above these annual gifting exemptions. Provided you live for seven years or more after making the gift, it will fall outside of the value of the estate.
Known as a “potentially exempt transfer” or PET, if you use the PET rules to gift and you die within seven years, taper relief rules apply.
This means that the amount of IHT applied depends on the number of years elapsed between the gift and your death.
The table below shows how the rate of IHT changes depending on how soon you die after making your gift:
Gifting money with a strategic approach could help you to transfer your wealth to your chosen beneficiaries’ during your lifetime, helping to reduce the size of your estate and the size of a potential IHT charge.
2. Gift regular amounts from your income
Another gifting option that can be useful in reducing the size of your estate is to make regular financial gifts.
For those concerned that their well-laid plans to pass their pension to beneficiaries as part of a careful estate plan will be scuppered, this option could be worth careful consideration.
Using the “gifting from income” rule could allow you to pass pension wealth on to your beneficiaries during your lifetime. And, as long as you stay within the rules, payments would be free of IHT.
To achieve this, clients could increase the amount of money they withdraw from their pension, boosting their income and allowing them to pass regular sums to their family and loved ones.
Ways to use this drip-feed gifting method include:
- Paying into a savings account for children under the age of 18
- Helping loved ones cover their mortgage, rent, or utility bills
- Providing financial support to an elderly relative.
To ensure your financial gifts remain free of IHT, payments should be:
- Made regularly
- Paid from regular monthly income
- Afforded without affecting your own normal standard of living.
Gifts from income must be part of your normal expenditure. This means clients will need to show a pattern of payments over an extended period of time. Generally, HMRC will look back over the past three or four years to see how often payments were made.
That said, unlike other gifting rules, gifts from income fall outside the estate right away and aren’t subject to the seven-year taper rule.
3. Leave your pension to your spouse
Of course, clients may wish to leave their pension to their spouse or civil partner. The spousal exemption would mean that this would automatically keep the pension funds outside the estate and would pass free of IHT.
Do note, however, that the spouse exemption cannot be used for IHT transfers arising from pension transfers, pension contributions, or placing pension funds in trust. This is because such transfers relate to the pension rather than the spouse. If this is a route your clients are considering, get in touch and we’d be happy to help.
Remember to complete or review your expression of wish
Your pension isn’t covered by your will. So, it’s crucial that you complete an “expression of wish” form with your pension provider.
If this is already complete and lodged with the provider, that’s great, but it’s important not to simply set and forget.
As with a financial plan or will, it’s sensible to review an expression of wish at least once a year to ensure that it remains appropriate, and matches your intent.
If someone has had several pension schemes over the course of their career, it’s not unusual to have multiple pensions and lots of different expression of wish forms. As such, it’s all too easy to overlook one that is nominated to an ex-spouse or partner, rather than to children or a current partner.
Get in touch
If your clients are keen to explore gifting their wealth to help mitigate a potential IHT charge on their estate, we can help ensure they have a sensible plan for this.
Using sophisticated cashflow modelling software, we can help clients visualise how much wealth they can comfortably gift, while still ensuring a sustainable income throughout their retirement.
Email mail@delaunaywealth.com or call us on 0345 505 3500.
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 or tax 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.
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