Pensions to be targeted by Inheritance Tax
Pensions will for the first time become subject to Inheritance Tax in 2027 under changes announced in last week’s Budget, dragging thousands more people into the IHT net.
Under current rules, pensions usually sit outside of your estate, and in most cases won’t count towards your inheritance tax threshold when you die. However, it was announced in the Budget that defined contribution pension pots will be subject to inheritance tax from April 2027.
The Chancellor Rachel Reeves said that there would now be a consultation into the proposed measures, which would see pension scheme administrators pay any IHT directly to HMRC when a member dies. Beneficiaries will still be subject to income tax at their marginal tax rates on anything further that they withdraw, if the person who left them a pension was 75 or over when they died. If the person who died was under the age of 75, there is no income tax payable.
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Chris Flower, Chartered Financial Planner at Quilter Financial Advisers, said: “One key aspect of this change is that passing on unused pension funds to a spouse or civil partner will remain exempt from IHT. However, payments to other individuals, such as children, will be included in your estate for IHT.
“Given the new IHT implications, it is imperative to review and, if necessary, update any existing expressions of wishes to ensure your pension goes to the correct beneficiary. If you do not have an expression of wishes in place, now is the time to complete one. Seeking financial advice is crucial to ensure that your wishes are clearly documented and that your beneficiaries are aware of the potential tax implications.”
The Budget changes mean that an estimated 10,000 more families are likely to end up facing an IHT bill when their loved ones die.
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Nigel Green, chief executive at deVere Group said: “For many, pensions are an inheritance lifeline, especially as homeownership becomes increasingly challenging. Families rely on these savings, not only as a means of supporting their retirement but also as a way to provide for their children and grandchildren.
“However, if Reeves’ plan goes into effect, families across the nation could see a massive shift in the legacy they can pass down. This move isn’t just an alteration; it’s an upheaval of a core financial planning tenet.”
The news was more positive for the State Pension in the Budget, with the Chancellor confirming that basic and new State Pension will increase by 4.1% from April 2025, in line with earnings growth, meaning over 12 million pensioners will gain up to £473 each in the 2025/26 tax year.
Mike Ambery, Retirement Savings Director at Standard Life, part of Phoenix Group said: “Pensioners across the country will be relieved to see no state pension shocks in the Budget as the Chancellor confirmed that the state pension will rise by 4.1% to match the average earnings element of the triple lock. This means that next year’s full new state pension is set to reach £11,975.60 annually, an increase of £473.
“This will come as welcome news to many, however there are possible tax implications for pensioners. The Personal Allowance, which is the amount of income you can receive before paying tax, has been frozen since at £12,570 since 2021/2022 and currently remains fixed in for quite a few years to come. This means that the full new state pension payment has grown from 70% of the allowance in 2019/20 to a likely 95% next year, leaving pensioners with only £594.40 of headroom before they begin paying income tax.”