Around 10,000 more estates are set to become liable for Inheritance Tax (IHT) from April, after changes announced in the Budget mean unused pension funds will count towards the value of a person's estate.
Former chancellor Rachel Reeves announced in her first Budget that from April 6, 2027, unused pension savings may be included in an estate for the purposes of IHT. Under current arrangements, unused pensions are usually paid tax-free, but under the changes they could be taxed as part of an estate.
Government estimates and average liabilities
The Treasury has insisted the changes are necessary to stop pensions being used or marketed as a way of transferring wealth rather than to fund retirement. Ministers estimate that an extra 10,500 estates will become liable for IHT each year.
The Government expects about 38,500 estates will pay more than would previously have been the case. The average IHT liability is expected to rise by around £34,000 when pension assets are included in the value of an estate, according to the Government.
How the tax applies
IHT is currently set at 40% on estates valued above the nil-rate band of £325,000 and the residence nil-rate band of £175,000. It is understood the forthcoming changes will apply to members who die on or after April 6, 2027.
For those who think they are likely to pay IHT, there are certain steps that can be taken to lower the bill. One option is to spend money, including what is in a pension, meaning there would be nothing left in the pension, though taking more money would likely mean paying more income tax.
Options to reduce the bill
Annuities should not come under the scope of IHT, so another way of reducing the bill might be to exchange a pension for an annuity. Annuities tend not to pay out after death, so a person would need to live for a fair amount of time to reap the benefits. Annuities which continue to pay after death are more likely to be hit by IHT.
Another way of reducing the bill is to gift assets, savings and income to loved ones. It is recommended that those who think they might incur IHT on their estate seek tailored advice from a financial advisor.
Who can inherit tax-free
Some people can inherit a pension tax-free. In general, income tax won't be taken if the owner of the pension died before they turned 75, but it will if the pension-holder dies after that age. This applies to most drawdown funds, Money Purchase pensions and annuities which pay out after the pension owner's death, with some exceptions.
If a Salary Scheme pension continues to pay out after death, then it doesn't matter how old the pension-holder was when they died – income tax is still due. The rules around 75 still apply if the scheme pays a lump sum.
