The Government’s recent announcement regarding changes to Inheritance Tax (IHT) on pensions, effective from April 2027, could impact estate and pension planning.
Currently, unused pension funds, particularly those held in discretionary pension schemes, are generally exempt from IHT.
However, from 2027, these exemptions will end, potentially exposing a broader range of pension funds to IHT.
Pensions and IHT – What is changing?
At present, discretionary pension schemes, such as some defined contribution plans, are exempt from IHT, allowing individuals to pass on unused funds without their value being added to their estate.
This has been a great tool for many in preserving wealth for future generations.
From April 2027, however, the rules will change:
- All pension types included – Both defined benefit and defined contribution schemes will be subject to IHT, with very few exceptions (such as certain dependants’ pensions).
- Broader tax exposure – Unused funds and death benefits, regardless of scheme type, will be included in the deceased’s estate for IHT purposes.
For those with significant pension savings, these changes could mean a substantial tax bill for beneficiaries.
The current nil rate band of £325,000 will remain, and the residence nil rate band (£175,000) may offer some relief, but the inclusion of pension funds could still push many estates over these thresholds.
The impact on your estate planning
This change has far-reaching implications for how pensions are viewed as part of overall estate planning.
Historically, pensions have been a tax-efficient vehicle for passing on wealth, but the new rules may alter this strategy.
As Kirk Vaughan, Director at Knights Lowe, explains: “These changes make it essential to review pension plans and ensure they are structured to minimise IHT liabilities. While pensions have long been considered outside the scope of IHT, this reform challenges that perception. Individuals must adapt their financial strategies accordingly.”
How to adapt
Planning effectively in light of the new Inheritance Tax (IHT) rules requires a clear strategy.
Here are five practical steps to help you prepare.
Review your pension structure
If you currently hold a discretionary pension scheme, you should assess whether this remains the most efficient vehicle for your retirement savings under the upcoming rules.
With the inclusion of all pension types in IHT, alternative structures may provide better tax efficiency.
“These changes mean pensions can no longer be treated as a straightforward inheritance tool,” says Kirk. Reviewing your pension structure now will give you time to explore better options and reduce potential tax exposure.”
Getting professional advice on reorganising your pension can help make sure it fits with both your retirement needs and your plans for passing on your wealth.
Utilise trusts effectively
Trusts remain a valuable tool in estate planning. By transferring assets into a trust during your lifetime, you can potentially shield them from IHT and provide greater control over how they are distributed.
As Kirk notes: “Trusts are a useful tool for protecting your money and managing the challenges of Inheritance Tax. For many of our clients, they have made a big difference in planning for the future.”
Plan withdrawals carefully
While pensions are often used as a financial safety net in later life, withdrawing funds strategically can help reduce the size of your estate and minimise IHT liabilities.
The key is finding a balance between reducing your estate’s value and ensuring you have sufficient income for your retirement.
“It is about striking the right balance,” Kirk advises. “By planning withdrawals carefully, you can manage your estate’s exposure to IHT without compromising your financial security.”
Start this process early to optimise the impact over time.
Leverage other tax allowances
The seven-year rule allows individuals to make tax-free gifts during their lifetime, provided they survive seven years from the date of the gift.
This is a simple but effective way to reduce the taxable value of your estate.
“Using gifting allowances under the seven-year rule is one of the easiest ways to minimise IHT,” notes Kirk. “It is surprising how many people overlook this opportunity.”
Additionally, take advantage of the annual gift allowance (£3,000 per year) and gifts for weddings or civil partnerships.
Review your Will and beneficiaries
You should update your Will to reflect the new Inheritance Tax rules.
Check that your chosen beneficiaries are up to date and take advantage of tax-saving options, like the residence nil rate band, which applies when leaving property to children or grandchildren.
Kirk explains: “Keeping your Will current is key to smart estate planning. Using the residence nil rate band properly can make a big difference in cutting down Inheritance Tax.”
With these changes not coming into force until April 2027, there is time to act – but don’t delay. Estate and pension planning are complex, and leaving things to the last minute could mean missed opportunities to optimise your financial position.
At Knights Lowe, we are here to help you make sense of estate and pension planning.
Our team can give you personalised advice to adjust to these changes and make the most of your finances.
Get in touch with us today to explore your options and make sure your plans are ready for the new rules.
