One of the key takeaways from the autumn budget was the Chancellors announcement that pensions will be subject to inheritance tax from April 2027. As things currently stand, passing pension funds to beneficiaries after death is free of inheritance tax, allowing individuals to pass on wealth through the use of pensions without those funds being subject to inheritance tax.
This proposed change will prompt many families to rethink how they organise their finances, and the importance of estate planning to mitigate their exposure to inheritance tax.
How does inheritance tax currently work?
Every estate has a tax-free allowance (known as the nil rate band) of £325,000. This allowance is set to remain in place until at least 2030. In addition this, there is an allowance of £175,000 (known as the residence nil rate band) for estates containing a residential property left to direct descendants. Anything left to a spouse or civil partner passes free of inheritance tax, and the aforementioned allowances are transferable between spouses and civil partners meaning for many married couples the first £1million of their estates is free of inheritance tax.
What currently happens to your pension when you die?
Generally speaking, pensions are not usually included when calculating the value of an estate for inheritance tax purposes. In turn this means that pensions aren’t normally subject to inheritance tax, which has made them a very powerful tool to pass on wealth.
If an individual were to die before they turned 75 their unused pension funds can pass to their beneficiaries tax free. If they were over 75 when they die the beneficiaries would not pay inheritance tax but would pay income tax on any income or lump sums received.
Because of this, many individuals have found themselves drawing down on other assets so as to pass on their pension free of inheritance tax on death.
What will happen to your pension if you die after April 2027?
The changes being brought in following the budget mean that the value of your pensions will be brought into your estate when calculating the overall value. According to government estimates, this could mean that an additional 10,000 estates will be liable for inheritance tax in the 2027/28 tax year. This will of course have a huge impact on many families, especially in cases where an individual dies earlier than expected with a sizeable pension pot of unused funds.
The changes are likely to push people into reviewing the plans they’ve put in place as pensions become a less attractive way to pass wealth down to the next generation.
How can Goughs help?
There are alternative ways to reduce your estate’s inheritance tax liability, allowing you to pass on wealth to your chosen beneficiaries. Our team of specialist lawyers can work with you to develop a thorough understanding of your circumstances and help plan your estate accordingly, taking into account the oncoming changes to how pensions are treated. It is important that individuals take specialist legal and tax advice in relation to their estates in order to maximise the reliefs available to them. Contact Goughs today to find out more.
