Changes to inheritance tax on pensions: what to expect from April 2027

In recent years it has been possible to pass pension funds to beneficiaries after death, free of inheritance tax (IHT). Many individuals have therefore drawn down on their other assets as they have got older so as to be able to pass on their pension free of IHT on death.

Currently, if someone dies before the age of 75 their unused pension can pass to the next generation completely tax free. If they die after 75 then there is not any inheritance tax to pay, but the recipients of the pension do pay income tax at their marginal rate on any lumpsums or income they receive from it.

In her speech the Chancellor announced that, from April 2027, any unused pension funds and death benefits payable from a pension will be brought into the inheritance tax net. It is not entirely clear how this will work in practice, and a consultation is taking place at present, running until 22 January 2025. It is, however, likely that where the deceased had a large pension the inheritance tax bill for the estate will be higher, and the availability of inheritance tax allowances may also be affected.

Every estate has a tax-free allowance of £325,000, known as the nil rate band or NRB (unless this has been used up if the deceased made large gifts in the seven years prior to their death). This will remain, with no changes to this allowance until at least 2030. There is also the possibility availability of an additional £175,000 Residence Nil Rate Band (RNRB) if the deceased is passing a residential property, in which they lived in or intended to live in during their lifetime (or an equivalent downsizing amount if they sold their residential property after July 2015), to a specified class of beneficiaries which includes their children, stepchildren and grandchildren. This has meant that for many married couples the first £1m of their estate can be passed on free of IHT.

However, if the value of the estate is larger than £2m the residence nil rate band starts to taper and is lost at the rate of £1 for every £2 above the £2m threshold. So, for a married couple whose combined estates on the death of second of them are worth £2.7m the additional allowance is lost altogether.

The IHT on pensions may therefore hit some estates twice. Take for example a widower with an £1.7m and a £1m pension pot. Currently (assuming he had both his own allowances and his late wife's) he will pay IHT on £700,000 as the first £1m would be tax free and there would not be any IHT to pay on the pension pot. This would mean an IHT bill of £280,000 (40% of £700,000). If the pension is included in the estate, then the estate will be valued at £2.7m, the residence nil rate bands will be lost and inheritance tax of £820,000 will be payable.

It will be worth waiting to see the outcome of the consultation to see how the changes will take effect. However, it will be important for those who are going to be affected to take advice.

For advice on the upcoming changes to changes to agricultural and business property, please contact Rachael Armstrong, in our Private Client team on 07879 630 734. Alternatively, you can fill out the form below.