Proposed Government changes to pension death benefits from 6^th April 2027 are set to have significant implications for estate planning.

At present, unused pension funds can typically be passed to beneficiaries outside of the estate for inheritance tax purposes. Under the proposed rules, however, unused pension funds are expected to be included in the value of an estate when inheritance tax is calculated from 6^th April 2027.

As a result, more estates will likely be brought into the scope of inheritance tax, and pensions may need to be considered differently as part of a wider Financial Plan.

How Could This Affect Your Beneficiaries?

One of the key issues is how inheritance tax and income tax may work together under the proposed changes.

Under current rules, the tax treatment of inherited pensions depends primarily on the age of the pension holder at the time of death:

• If death occurs before age 75, pension benefits can often be passed on to beneficiaries free of income tax, as well as inheritance tax.
• If death occurs from age 75, beneficiaries usually pay income tax on withdrawals at their marginal rate. Typically, the pension is still received free of inheritance tax.

From 6^th April 2027, when unused pension funds are brought within the scope of inheritance tax, both income and inheritance tax could apply where death occurs from age 75. This could effectively result in a form of double taxation for the pension fund, facing inheritance tax (at up to 40%), followed by income tax (at a rate between 0% to 45%).

Who Pays the Inheritance Tax?

Currently, inheritance tax is typically paid by the executors of the estate before assets are distributed to beneficiaries. However, where pension funds will be included in an estate under the new rules, the beneficiaries of the pension may also be responsible for part of the tax due.

The current expectation is that if inheritance tax is due, the Personal Representatives of the ‘free estate’ (excluding pensions) and the pension beneficiaries will be jointly and severally responsible for the tax liability. The proposals give some flexibility in how inheritance tax due on the pension can be paid, including allowing the tax to be paid directly from the pension where the provider allows it. There is also expected to be scope to settle the liability due on the pension using assets from the ‘free estate’. Ultimately, however, any inheritance tax due in respect of the pension is likely to be ‘footed’ by the pension beneficiary in some way.

What Does This Mean for Your Financial Plan?

Pensions have long been seen as a valuable estate planning tool because of their favourable tax treatment. The proposed rule changes are prompting many to review how their retirement and estate plans are structured.

When reviewing client’s planning, key areas that we consider are:

• The suitability of ongoing pension contributions, weighing up tax relief against potential future taxation
• The order in which assets are withdrawn during retirement
• Making use of tax allowances where pension withdrawals are to be made
• Assessing whether current pension beneficiary nominations are appropriate
• Assessing potential inheritance tax liabilities for estate and pension beneficiaries
• Reviewing broader estate and inheritance tax planning strategies for tax efficiency

The most suitable approach will depend on your personal circumstances, objectives for yourself and your family, and any plans that you already have in place.

Planning Ahead

While the new rules are not expected to take effect until 6^th April 2027, with the legislation not likely to be finalised until Spring 2027, they are a reminder of the importance of regularly reviewing your Financial Plan, particularly where pension wealth has been built up over a lifetime and forms a significant part of your retirement assets.

If you would like to discuss the proposed changes and how they might affect your own planning, please reach out to a member of the team.