Pensions and Inheritance Tax (IHT)
The changes you need to know
In Labour’s first Budget in 2024, Chancellor Rachel Reeves announced plans for a major shift in pension legislation.
Subject to the Finance Bill being ratified, these proposals have now been confirmed and, from April 2027, inherited pensions will become subject to Inheritance Tax (IHT). This marks a significant departure from the current rules, where pensions are generally excluded from IHT calculations.
What is the position now?
Under current rules, pension funds that have not been used to purchase an annuity can be passed on to a spouse or nominated beneficiary on death.
- Death before age 75: beneficiaries can typically withdraw inherited pension funds free of Income Tax.
- Death after age 75: beneficiaries pay Income Tax at their marginal rate on any withdrawals.
Crucially, pension funds are not normally treated as part of the deceased’s estate for IHT purposes, making pensions an attractive vehicle for both retirement income and intergenerational wealth planning.
What is changing?
From April 2027, any unspent pension assets on death will be included in the estate for IHT calculations.
The impact depends on the total value of your estate.
- If the value of your estate is above £325,000 (or £500,000 if you’re leaving your home worth £175,000 or more to a direct descendant and the overall estate is less than £2 million), any pension funds above this threshold will be liable for IHT at 40%.
- If death occurs after age 75, beneficiaries may face both Income Tax and IHT on the same pension funds.
This combination creates a potential effective tax rate of 52% for a basic rate taxpayer or 64% for a higher rate taxpayer where the pension pot exceeds the available IHT allowances.
Further Budget announcements
In the most recent Budget, Reeves delivered news that further changes to pensions were coming.
These include plans to charge National Insurance on salary sacrifice contributions above £2,000.
Further details about this can be found in our article: Salary sacrifice pension cap announced in the Autumn Budget 2025.
What isn’t changing? The good news!
Many of the changes that were predicted to happen did not materialise.
- You can still take up to 25% tax free cash from your pension (subject to protections).
- The funds within your pension will continue to grow free of Capital Gains Tax and Income Tax.
- Contributions made to your pension within the specified rules will still attract tax relief at your marginal rate of Income Tax.
- The triple lock commitment for state pensions is to remain in place.
The other good news is that the spousal exemption looks set to stay. This means any funds left to a surviving spouse or civil partner will continue to be free of IHT upon the first death.
The bad news!
Unfortunately, Reeves also confirmed in the Autumn Budget 2025 that the £325,000 threshold for IHT will now be frozen until April 2031. A threshold unchanged since 2009/2010.
If your estate includes a family home being passed to children or grandchildren, you may benefit from an additional £175,000 Residence Nil Rate Band (RNRB). However, this allowance tapers once the estate exceeds £2 million, reducing by £1 for every £2 above this level.
With the addition of pensions in estate calculations and with rising property and asset values, many more are expected to exceed these thresholds and face considerable IHT charges as a result.
New plans needed
These changes highlight the need for careful planning and the importance of reviewing your strategy. With the new rules taking effect in 2027, there’s still time to evaluate and update your current financial plans.
It is a good time to take the opportunity to speak to your Financial Adviser to understand how the new rules will impact your position. Changes can then be made to your financial plan to ensure that you can continue to achieve a balance between meeting retirement income needs and passing assets to your loved ones in a tax-efficient way.
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DisclaimerCrowe Financial Planning UK Limited is authorised and regulated by the Financial Conduct Authority (‘FCA’) to provide independent financial advice. The information set out in this publication is for information purposes only and is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. It does not constitute advice to undertake a particular transaction. Appropriate professional advice should be taken on specific issues before any course of action is pursued. Any advice provided by a Crowe Consultant will follow only after consideration of all aspects of our internal advice guidance. Past performance is not a guide to future performance, nor a reliable indicator of future results or performance. The value of investments, and the income or capital entitlement which may derive from them, if any, may go down as well as up and is not guaranteed; therefore investors may not get back the amount originally invested. A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The Financial Conduct Authority does not regulate Trusts, Tax or Estate Planning. |
