For years, pensions have been an effective estate planning vehicle for transferring significant wealth to loved ones without incurring an inheritance tax (IHT) charge on death. However, from 6 April 2027 the IHT rules surrounding pensions are set for a radical overhaul.

HMRC has published further details on how the new regime for pensions and IHT will operate. This article explores HMRC’s latest technical note and how to prepare for the changes.  

What is Changing?

HMRC’s technical note confirms that most unused pension funds and certain death benefits (referred to as “notional pension property”) will no longer be exempt from IHT and will instead be brought within the value of a deceased person’s estate for IHT purposes from 6 April 2027.

Under the new regime, the personal representatives will be required to identify all of the pensions that an individual was entitled to just before they died. The pension scheme administrators must provide the personal representatives with the value of the pension benefits within 4 weeks of being notified of the death.

The personal representatives will also be responsible for reporting and paying the IHT due on those pensions, with IHT being due at the end of the sixth month after death, and late payment interest will accrue on any outstanding tax.

HMRC have also introduced a “withholding notice”, which allows the personal representative to give notice to the pension scheme administrator if they know, or reasonable believe, that they may be liable for tax attributable to the pension. Whilst the withholding notice is in effect, the pension providers can withhold up to 50% of the pension funds for up to 15 months in order to safeguard the pension whilst the IHT is being settled.

Which pensions will be excluded?

Whilst there are a lot of changes taking place from 6 April 2027, there are certain protections that will remain in place:

1. Spousal exemption: benefits paid to a surviving spouse or civil partner will be exempt from IHT.
2. Charitable legacies: pensions left to qualifying charities will remain exempt from IHT.
3. Dependant’s pensions: pension payments to surviving dependants will remain outside of the estate.
4. Death in service benefits: these will remain outside the scope of IHT (although require careful planning to ensure the best tax efficiency).

How to prepare for the changes

There are a number of planning opportunities to consider before the 6 April 2027:

1. Review your Will - is it tax efficient for IHT? Does it still reflect your wishes?
2. Get up to date valuations of all of your assets, including your pensions. This will then enable you to consider whether the value of your estate exceeds the available IHT allowances. It will also allow you to see if the estate is at risk of losing the residence nil rate band allowance (applicable where a person’s estate exceeds £2 million).
3. Review death benefit nominations regularly and seek professional advice.
4. Gifts out of surplus income - if you have excess income each year from your pension (i.e. income you do not spend on your day-to-day living), you might consider making regular gifts out of the excess. Any gifts made out of surplus income are immediately IHT free.
5. Utilise tax-free cash. You can still withdraw up to 25% of your pension as a tax-free lump sum. Once the pension funds are withdrawn, you can then gift the funds to reduce your future IHT liability. Making a gift of the cash withdrawn would be a potentially exempt transfer for IHT and will fall completely outside of the estate provided that you survive 7 years.
6. Consider taking out life insurance cover to cover the IHT liability. This involves paying premiums on a whole of life or term life insurance policy to help with covering the IHT liability due on death. This is particularly useful for those who may have limited liquidity in their estate.  
7. For those that are approaching 75, or are over 75, consider taking pension benefits so that you can mitigate against both IHT and income tax on death. Under the new rules, pensions funds could be subject to both IHT and income tax. IHT would be calculated on the value of the pension as part of the estate, but when beneficiaries draw down the funds, they would also pay income tax at their own marginal rate. The combination of IHT and income tax will mean that the rate of tax on death benefits can be significant.
8. Spend the pension fund and do IHT planning with other assets that you own.

The Private Wealth team at JMW Solicitors have a wealth of experience when it comes to advising on all forms of tax mitigation, so please do contact a member of the team if you are considering your pension and the IHT changes.