Since the pension flexibility changes in 2015, many clients have utilised pensions as an effective means to transfer wealth across generations. This strategy has been particularly appealing due to the IHT advantages pensions offer.
Assuming that pension funds automatically remain within the pension wrapper for beneficiaries can lead to disappointment—especially if the pension provider or policy structure doesn’t support that flexibility. A common issue is that some older pensions, particularly those taken out before 29 April 1988, still form part of the plan holder’s estate and have limited or outdated death benefit options. In many cases, the only outcome is a lump sum payout, rather than allowing the pension to pass to beneficiaries in a tax-efficient manner or remain invested in a pension environment via beneficiary drawdown.
However, recent developments indicate significant changes on the horizon.
What’s Changing from April 2027?
As announced in the Autumn Budget 2024, from 6 April 2027, most unused pension funds and death benefits will be included in the value of a person’s estate for IHT purposes. This means that if the total value of your estate, including your pension, exceeds the IHT threshold, your beneficiaries may be liable for IHT on the pension portion of your estate.
Previously, newer style pensions with drawdown options were generally excluded from IHT calculations, allowing them to pass to beneficiaries without incurring additional tax. However, this exemption is set to end, aligning pensions with other assets for IHT purposes.
How to Make Sure Your Pension Goes Where You Want It To
The critical factor is whether your pension provider supports flexible death benefit options such as beneficiary drawdown. If your pension plan is old or from a closed scheme, it may not offer this facility, meaning your loved ones could be forced to take a lump sum payout, bringing the money into their estate and potentially exposing it to IHT.
Even where a lump sum is not subject to IHT (for example, if the pension holder dies before age 75), it still takes the money out of the pension wrapper, potentially losing long-term tax advantages.
Some older plans may still hold valuable benefits, such as guaranteed annuity rates, which shouldn’t be given up lightly. This makes reviewing your pension arrangements with a professional adviser even more important.
What Do the Proposals Mean for Beneficiaries?
Beneficiaries may face both IHT and income tax on inherited pensions:
- If you die before age 75: Your beneficiaries can inherit your pension tax-free, but the pension’s value will be included in your estate for IHT purposes.
- If you die at age 75 or older, Your beneficiaries will pay income tax on the inherited pension at their marginal rate. Additionally, the pension’s value will be included in your estate for IHT purposes, potentially leading to double taxation.
What Can You Do Now?
- Review Your Pension Arrangements: Ensure your pension provider offers flexible death benefit options, such as beneficiary drawdown, which allows funds to remain within the pension wrapper.
- Consider Transferring to a New Provider: If your current provider doesn’t offer flexible options, transferring to a provider that does may be beneficial. However, be cautious of losing valuable benefits, such as guaranteed annuity rates, when transferring.
- Seek Professional Advice: Given the complexity of these changes, consulting with a financial adviser is crucial to develop a strategy that aligns with your estate planning goals.
This is where we can help. We can advise you in this area and offer actively managed risk-graded portfolios. If you would like more information or any advice on this article, then please get in touch by emailing Chris Slater cslatter@ellacottswealth.co.uk or Jo Mara jmara@ellacottswealth.co.uk.
Information for readers: This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore, no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.
