Columnist

What pension rule changes could mean for you

The UK pension system is a cornerstone of retirement planning, offering individuals a structured way to save for later life. 

As of now, pensions enjoy several tax advantages, including significant reliefs during the accumulation phase and, in many cases, exemptions from inheritance tax. 

However, from April 6 2027, a major shift in how pensions are treated for inheritance tax purposes is set to take place, which has potential to impact thousands of estates across the country.

Current pension rules

Presently, defined contribution pensions – where individuals build a pot of money to draw from in retirement – are generally not considered part of a person’s estate for inheritance tax purposes. 

This means that if someone dies before accessing their pension, the remaining funds can usually be passed on to beneficiaries tax-free, provided the death occurs before 75. 

Even after 75, while income tax may apply to withdrawals by beneficiaries, the pension itself is not subject to inheritance tax. 

This favourable treatment has made pensions an effective estate planning tool. 

Many individuals have opted to draw income from other sources in retirement, preserving their pension pots to pass on to beneficiaries in a tax-efficient manner.

What is potentially changing?

From April 6 2027, the Government intends, subject to consultation, to implement a significant change: most unused pension funds and death benefits will be included in the value of a person’s estate for inheritance tax purposes.

This means pensions will no longer be automatically exempt from inheritance tax, and the standard 40 per cent tax rate could apply to any amount exceeding the nil-rate band.

The nil-rate band – the threshold below which no inheritance tax is due – remains at £325,000 per individual. 

For married couples or civil partners, this can be combined to £650,000 if unused allowances are transferred. 

However, with property values and pension pots often exceeding these thresholds, many more estates could now face inheritance tax liabilities.

It should be noted the usual inheritance tax spousal exemptions will apply to pensions and, therefore, no inheritance tax will be payable if a pension passes to a surviving spouse.

Who will be affected?

According to Government estimates, around 10,500 estates will pay inheritance tax for the first time due to this potential change, and approximately 38,500 estates will see an increase in their bill.

This shift is particularly relevant for individuals with substantial pension savings who may not have drawn down their funds before death.

It’s also important to note the change applies to both UK-registered pension schemes and qualifying non-UK pension schemes.

The inclusion of pensions in the estate for inheritance tax purposes will apply regardless of whether the funds are paid out as a lump sum, beneficiary’s drawdown or annuity.

Administrative implications

From April 2027, pension scheme administrators will be required to report and, in some cases, pay any inheritance tax due on unused pension funds to HMRC.

This represents a significant shift in the role of pension providers and may lead to increased complexity in estate administration. 

The Government is currently consulting on the processes required to implement these changes.

Planning ahead

For people in the accumulation phase of life, it is still worth considering pensions as a way of saving for retirement. 

However, for those approaching retirement or already enjoying life after work, they may want to consider reviewing their retirement and estate plans.  

Some potential strategies include:

·      Drawing down pension funds earlier – This could reduce the amount left in the pension at death, potentially lowering inheritance tax exposure

·      Gifting pension withdrawals – Once withdrawn, funds can be gifted and may fall outside the estate if the individual survives for seven years or potentially immediately if they fall within the regular gifts from surplus income rule

·      Using pension funds to fund life insurance – Consider taking out a whole-of-life insurance policy to cover some or all of the potential future inheritance tax liability

·      Using other assets first – Continuing to use non-pension assets for retirement income may still be beneficial, depending on personal circumstances and tax implications

Conclusion

The likely upcoming changes mark a significant shift in the UK’s retirement landscape. While the reforms aim to create a more equitable tax system, they also introduce new complexities for individuals and families. By taking proactive steps, pension savers can better prepare for the evolving environment and ensure their wealth is passed on as efficiently as possible.

Rob Brotherton is a chartered wealth manager at Newcastle-based Raymond James Monument.

Any opinion or forecast reflects the judgment as at the date of issue and is subject to change without notice. Past performance is not a reliable indicator of future results. This commentary is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person. With investing, your capital is at risk.

For more information, email rob.brotherton@raymondjames.com or visit www.monument.raymondjames.uk.com

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