Rachel Reeves’ announcement in her autumn Budget that from 2027, pensions will no longer be exempt from inheritance tax was one of a number of measures designed to increase tax revenues.
Only the headline was unveiled; the detail will come after a consultation which has already run beyond its original projected period, and which, at time of writing, shows no sign of an imminent conclusion.
Because of this, we have seen some people put all of their inheritance tax planning on hold, on the basis that we can’t second-guess what the final pension measures will look like. However, given the already protracted nature of the consultation, putting off thinking about mitigating IHT could be costly, not just because that 2027 deadline will soon come around, but also because IHT planning is about much more than pensions.
And in any case, although we don’t know the details of the mechanics (for example, whether the pension provider or the executor will be responsible for actually paying any IHT), we can be pretty certain that this is one measure where there is unlikely to be a U-turn on the basics: whatever the processes finally announced, it seems pretty certain that defined contribution pension pots will fall under the reach of IHT from April 2027.
Many people have pension pots worth more than the current nil rate IHT band (£325,000), so this is a measure which is likely to affect a significant number of people.
Of course, each case will require an individual approach, and there is no ‘one size fits all’ solution. But there are some considerations which should be considered by those looking to minimise the effects of the Chancellor’s decision.
The first obvious thing to think about is whether to withdraw the tax-free 25% from your pension if you have not already done so; this potential tax-free cash could be used for formal inheritance tax planning or to support income or capital expenditure.
Inheritance tax is currently levied at 40%, so taking taxable income from a pension, even if that means incurring income tax at 20%, may be beneficial. This income could then be used to make gifts from surplus income, which via the gifts from surplus income exemption are outside the remit of IHT.
One important consideration: currently, if you die before the age of 75, your beneficiaries can receive the income from your pension free of income tax; after that, they will pay income tax on what they receive from the pension they inherit. This raises the spectre of double taxation from April 2027: inheritance tax payable on the pension pot itself, and then income tax when money is withdrawn from it.
Perhaps the key point here is that pensions should be used as a vehicle for funding retirement, not for inheritance tax mitigation.
Uncertainty about how the new measures to remove the IHT exemption from pensions in 2027 should not be a reason to delay overall inheritance tax planning; it is only the details which we don’t know yet, we can be pretty certain that it will happen.
The two years before it does give everybody a window to take measures to minimise the effects; but those two years will soon pass. It is certainly not too early to be seeking expert advice.