Currently, funds built up in a defined contribution pension are not normally included in your estate when you pass away, and inheritance tax does not apply. However, this is changing from 6 April 2027, when unused pension funds and death benefits are expected to form part of an individual’s estate for inheritance tax purposes, subject to the final legislation and HMRC rules.
What is inheritance tax?
Inheritance tax (IHT) is a tax payable on the estate (the assets, such as a house, savings and possessions) of someone who has died. The standard rate of inheritance tax is 40%, but this is only charged against any part of your estate that exceeds the IHT threshold (termed the Nil Rate Band – currently £325,000) and any available Residence Nil Rate Band (currently up to £175,000).
There is also no IHT payable when a spouse or civil partner inherits your assets, and married couples or those in a civil partnership can share their Nil Rate Bands, meaning an estate of up to £1million could potentially have no IHT to pay.
What is changing?
Currently, unused pension funds, including funds held in drawdown, can normally be ignored for IHT purposes. It was announced in the Autumn Budget in October 2024 that this would change from 6 April 2027.
As the legislation has not yet been fully implemented, the final rules and practical application may be subject to change.
What do you need to do?
It is important to highlight that the change to the IHT treatment of pensions is unlikely to require any change to your retirement plans. For most people, their pension is a tax-efficient way to build up a pot of money while they are working, to provide an income when they retire, and that is still very much the case.
It is possible that the new rules will lead to delays in pension companies being able to pass on funds. You should ensure that you have notified your pension provider of your chosen beneficiaries using an Expression of Wish or Death Benefit Nomination, as this can help to reduce delays as well as providing your beneficiaries with more options.
You should also check that your nominated beneficiaries are still up to date, particularly if your pension was set up a long time ago or your circumstances have changed.
Those with larger estates may need to reconsider their planning around IHT, and how best to pass on their assets in a tax-efficient way.
Inheritance tax treatment depends on individual circumstances and may change again in the future.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.
This article is for information only and should not be construed as advice or a recommendation. You should always seek independent financial advice prior to taking any action.
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