Changes to Inheritance Tax on private pensions

The new Labour government recently announced a series of changes, including one that will impact how private pensions are treated for Inheritance Tax (IHT) purposes. From April 2027, private pension pots will be included in the value of an individual’s estate when calculating their IHT liability. This could significantly increase the IHT charge on estates, especially for those with large pension pots. 

What’s changing? 

Under current rules, private pensions are not included in your estate for IHT purposes, meaning the value of your pension pot is excluded from the total assets when calculating IHT. As a result, you can pass on up to £325,000 worth of assets (the nil rate band) without paying IHT. If certain conditions are met, you can also pass on a further £175,000 from your family home to direct descendants, which reduces your IHT bill. 

For pensions: 

• If you die under 75, your pension pot can be inherited tax-free (with some exceptions for lump sums)
• If you die at or over 75, your pension pot is subject to income tax at the beneficiary’s marginal rate when they access it

What happens after April 2027? 

The big change is that, from April 2027, your private pension will be included in your estate when calculating IHT. This could push your estate above the IHT threshold, meaning your beneficiaries could face a higher tax bill. Plus, the nil rate band of £325,000 will be frozen until 2030, so it won’t rise with inflation, and more estates will be hit by IHT as asset values increase. 

An important point to note: the changes won’t apply if your pension pot passes to your surviving spouse, so they won’t face IHT on it. 

Example to illustrate the impact 

Let’s say an individual’s estate is worth £2.75m, made up of: 

• £1.5m in property (passed to descendants)
• £500,000 in investments
• £750,000 in pension pot

Under the current rules, only the £2m of assets above the £325,000 nil rate band would be considered when calculating IHT, and tax would be applied accordingly. 

However, after April 2027, the £750,000 pension pot will be added to the estate value. This means the total estate will be valued at £2.75m, which will trigger more IHT due to the value of the pension pot now being part of the estate. In this case, the residence nil rate band will also be tapered down to zero, and the estate will face an additional £440,000 in IHT. 

How to reduce the impact of these changes 

While we await more detailed guidance from HMRC, there are several strategies individuals can explore to potentially reduce the impact of these upcoming IHT changes. Broadly speaking, it may be worth considering how to structure your estate, including your pension pot, to minimise IHT exposure. This could involve reviewing the beneficiaries of your pension, exploring opportunities for tax-efficient gifting, and considering ways to reduce the value of your estate during your lifetime. It’s important to work closely with a tax advisor to ensure that any steps you take are tailored to your specific financial situation and objectives. 

What next?

If you have any questions about anything covered in this article, get in touch with one of our experts here at Gravita.