The Budget announcement to make pension pots liable for Inheritance Tax (IHT) has potentially big implications for retirement plans.
While most people won’t be impacted, the change could disrupt the financial plans of those who are, and those plans may require reorganisation to ensure they remain tax efficient and meet financial goals. This change isn’t happening straightaway though – the government plan to bring pension funds into a person’s estate for IHT from 6 April 2027.
When does IHT bite – and what will change?
IHT only begins to apply when an estate – including money held in cash or investments, property, and other possessions – reaches a certain size. Up to £325,000 can be passed on with no IHT due. This is known as the “nil-rate band”. Anything over this can potentially face40% tax, but several exemptions can provide more headroom. Firstly, money passed to a spouse or civil partner attracts no IHT; spouses and civil partners can also pass unused nil-rate bands to each other. There is a further exemption if the estate includes a primary residence, which means an extra £175,000 of nil-rate band per person. Taken together, these exemptions mean someone could pass on as much as £1 million with no IHT to pay.
Pensions – no longer an IHT haven
In recent years, pensions have emerged as a powerful way for people to mitigate IHT. That’s because pensions have been treated differently on death from other assets.
Pensions currently fall outside of a person’s estate and can therefore be passed to beneficiaries without IHT applying. If death occurs before age 75, then no tax applies and if after age 75, then the beneficiary pays Income Tax at their own marginal rate.
This has led some people to organise their retirement finances in a way that preserves money held in their pension so it can be passed on free of IHT, using other sources of retirement income – such as ISAs – before turning to their pension. The Budget reforms change this equation.
Double taxation?
Some observers have complained applying IHT to pensions will result in double taxation. For example, where IHT is due, £100 of pension money would be subject to 40% tax, leaving £60. If death occurs after age 75, this money would then be subject to the beneficiary’s rate of Income Tax. This could be as high as 45%, resulting in just £33 being received by the beneficiary – an effective tax rate of 67%.
It’s important to note the rules have not yet been finalised and revisions could happen before they come into force.
Ways to reduce an IHT bill
Tax rules contain important allowances and exemptions that can reduce an IHT liability. Notably, there are instances where gifts can be made.
You can gift any amount with no IHT to pay if seven years pass without you dying. If you die within seven years, a reduced rate applies to any amount above your nil-rate band (although if death happens before three years has passed the full 40% rate applies).
You can also give away £3,000 per year of assets or cash without IHT applying at all. This exemption can also be carried forward so you can gift £6,000 if you haven’t used the exemption from the year before. £250 can also be gifted per person, per year, to as many people as you like – although not to someone who has already benefitted from your £3,000 annual allowance. You can also give £1,000 to anyone if you’d like to help pay for their wedding, rising to £2,500 for a grandchild and £5,000 for a child. The gift has to happen before the big day though, not after.
There are several other payments which can be made such as helping pay for the living costs of a child under age 18, or in full time education, as well as regular amounts, that you don’t need from your income, without IHT applying (but not capital itself).
If using either of these exemptions, it may have to be demonstrated that the money was not excessive or needed to ‘maintain your standard of living’.
Inheritance tax rules can be very complicated and this change relating to pensions could necessitate changes to your financial plan and how you drawdown your income in retirement. It’s therefore very important to seek financial advice from your 2plan adviser to ensure your plans remain on track and that any actions you take are right for you and your loved ones.
Author: Fidelity Adviser Solutions Source
--- [2plan Newsletter Edition 46 - 2026]
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