Sea of tax changes? Why getting your ducks in a row on pensions is vital
Inheritance tax changes may feel a long way away, but sooner is better when it comes to structuring your assets to pass on as much wealth as possible to your loved ones, says Duncan Bailey
The Budget has given businesses and individuals much to consider with announcements made around spending, national insurance contributions for employers and arguably, the most deliberated – taxation.
As part of the government’s proposed changes to inheritance tax (IHT), Rachel Reeves announced that from April 2027, pensions will be considered as part of a deceased’s estate, and unused pension pots will be subject to inheritance tax at a rate of 40 per cent, which is expected to raise nearly £1.5bn.
While 2027 may feel a long while away, sooner is better when it comes to financial planning and using strategies such as restructuring estates or gifting assets to ensure as much wealth as possible is passed onto your loved ones should be a priority.
The threat of ‘double taxation’
Pensions have traditionally been part of an individual’s estate planning. While they are used predominantly to build wealth and prepare for retirement, up until now they have also provided a simple way to leave money to your loved ones, as under the current law you can leave a pension to your next of kin, free of inheritance tax.
Following changes to pensions in the Budget, one of the concerns being raised by our clients is ‘double taxation’ – essentially where a pension pot may end up being taxed twice.
If the pension holder dies before they turn 75 years old, when their pension is withdrawn, the recipient will not pay income tax, although IHT may be added from April 2027. However, if they die after turning 75, there can be the inheritance tax bill plus income tax when the pension is drawn upon – hence a double tax hit.
Plus, if the deceased’s pension pushes the total value of their estate over £2m, the IHT residence nil rate band would no longer apply, meaning the next of kin faces triple taxation.
The pension was once a prized and secure estate planning asset, however careful consideration and planning is now required to mitigate the potential negative impact of the new taxation regime.
Clients are coming to us for advice on what can be done to deal with their pension in a tax efficient manner, and trusts may once again become common place in how pension pots are nominated. Specifically, a bypass trust can be set up to receive pension death benefits so they don’t sit in the estate of the beneficiary subject to a further hit to Inheritance Tax.
How pension changes work in practice
Changes to pensions won’t only affect individuals – it will also be a significant change for pension scheme administrators. From April 2027, reporting and paying IHT on pensions will now be their responsibility, which will require a significant change in how they operate.
There’s also an added time constraint. If the process to pay the IHT bill takes longer than six months, HMRC starts to charge interest. There are concerns over whether it will be possible to track down all pensions that the deceased has paid into over their lifetime, get values for these and then add them to other assets to determine the overall IHT due, and pay this within six months after death to avoid interest. This process will undoubtedly have teething problems in its early stages, like any new policy reform.
Looking ahead
Finance is a highly emotive topic – ultimately it dictates how we provide for our loved ones. With that comes sensitivities and stresses, and these proposed changes to pensions can cause a degree of uncertainty.
Turning to legal and financial advisors, who can give clarity around the complexities in estate planning and help you prepare for what the future might hold, is crucial.
While April 2027 may feel a long way off, getting your ducks in a row will ensure you’re ready when the changes come in.
Duncan Bailey is partner and head of private client & charity at Brabners Personal