Inheritance tax and pension savings

Some people may have been saving into a workplace or other defined contribution pension with the intention of using it to transfer wealth to future generations. Currently, this is possible because pension savings aren’t normally part of someone’s estate for inheritance tax purposes.

However, the rules are set to change. As announced in the Autumn Budget Statement 2024, the government plans to include unused pension savings and pension death benefits within an individual’s estate for inheritance tax purposes starting 6 April 2027.

It’s important to note that death in service benefits, whether discretionary (where the scheme administrator or scheme trustees decide who benefits) or non-discretionary (where an individual has chosen who benefits), won’t be affected by these changes.

Who will these changes affect?

Not everyone will be affected by these changes. We know that some people aren’t saving enough into their pension savings, let alone thinking about passing on unused funds.

Currently, there’s normally no inheritance tax to pay if the value of an estate is less than £325,000. Anything over this amount could be taxed at a rate of 40%. Adding unused pension savings to someone’s estate will mean more estates may have to pay inheritance tax. In fact, the government estimates that 10,500 estates will pay inheritance tax for the first time once these changes are implemented.

This is draft legislation, so some details could change.

Exemptions

The current exemptions still apply: 

• If someone who is married or in a civil partnership dies, they can pass on anything they own to their spouse or civil partner without paying inheritance tax.
• The surviving spouse or civil partner then has an increased inheritance tax threshold of £650,000 before inheritance tax is paid on their estate.
• Leaving everything above the £325,000 threshold to a charity means no inheritance tax is payable.
• The residence nil rate band of up to £175,000 can apply if someone owns (or part-owns) a property and leaves it to children, including adopted, fostered, or stepchildren, or grandchildren.
• If the property is passed to a spouse or civil partner, there’s no inheritance tax to pay.
  
  

How is inheritance tax paid?

If there’s an inheritance tax liability, current proposals outline three options for paying the inheritance tax charge related to the pension element. It’s the responsibility of the personal representative to make sure the correct tax is paid.

1. Any inheritance tax due can be paid from the free estate, which is anything that isn’t the pension element.
2. The person receiving the death benefit can ask the pension scheme to pay the inheritance tax for the pension element, directly to HMRC. The scheme will then distribute the remaining benefits to the beneficiaries.
3. Alternatively, the person receiving the pension death benefit can take the benefits in full, pay any income tax due, and then make the inheritance tax payment to HMRC. They can then reclaim any income tax paid on the pension benefits used to pay the inheritance tax charge.
   
   

What’s next?

These changes won’t take effect until 6 April 2027, but it’s important for you and your employees to know about them now to plan ahead. We’ve created an article, Changes to inheritance tax (IHT) on pensions from 2027, that you can share with your employees to give them more information.

If they think these changes might affect them, they should speak to a financial adviser. There’s a link in the article to help them get advice if they don’t already have an adviser.