The 2024 Autumn Budget brought some important changes to the way pension death benefits will be taxed.
The new rules mean that most unused pension death benefits will be included in your estate for inheritance tax (IHT) calculations.
The rules are set to kick in on 6 April 2027.
These changes could leave many retirees having to rethink their IHT plans.
See Adam's full adviser profile for more information, including the range of advice he offers.
How will the changes work?
The changes are subject to a consultation, so nothing is guaranteed yet. But here’s what’s being proposed.
When someone passes away, the pension provider and the people handling the deceased's estate will work closely together to manage the process.
The people handling the estate will use an HM Revenue and Customs (HMRC) calculator to find out whether any IHT is due and, if so, how much of the nil rate band applies to the pension.
They’ll let the pension provider know this information, and then the pension scheme will calculate the amount of IHT due on the pension. The pension provider will then pay the necessary tax directly to HMRC before paying the remaining death benefits to the beneficiaries.
If the deceased has a spouse or civil partner and the pension is paid to them, it won’t be subject to IHT because of the IHT exemption for spouses.
What impact could these changes have to your inheritance tax bill?
The following examples are based on a married couple who first leave the estate, including their home, to the surviving partner and then to their children.
Let’s say you owned the following assets:
Your total combined current assets (property, cash, and investments) = £1.7mn.
You also have a pension worth £1mn, but for now, it isn’t counted as part of your estate for inheritance tax (IHT).
Current situation (before April 2027):
Your estate: £1.7mn (the pension isn’t included).
Tax-free allowance: £1mn (two x nil rate band and two x residence nil rate band added together).
Taxable estate: £1.7mn - £1mn = £700,000.
Inheritance tax: 40% of £700,000 = £280,000.
New rules (from April 2027):
Pension now counted: your estate becomes £1.7mn + £1mn (pension) = £2.7mn.
Lose tax-free allowance: because your estate’s worth £2.7mn, you lose the residence nil rate band (worth up to £350,000). The residence nil rate band is reduced by £1 for every £2 that your net estate is over £2mn.
Tax-free allowance drops: now only £650,000 of your estate is tax-free.
Taxable estate: £2.7mn - £650,000 = £2.05mn.
Inheritance tax: 40% of £2.05mn = £820,000.
£540k
Impact of the new rules:
Current tax liability: £280,000.
New tax liability: £820,000.
Extra tax: £820,000 - £280,000 = £540,000 more in tax.
The changes mean a much bigger chunk of your wealth could go to taxes instead of your loved ones.
Time for a strategy refresh – 3 things you can do
With these changes on the horizon, it’s a great time to reassess how you’re using pensions in your retirement and estate planning.
Here are three strategies to consider.
This article isn’t personal advice. If you’re not sure what’s right for you, ask for financial advice. Remember, pension, ISA and tax rules can change, and any benefits depend on individual circumstances. You also can’t access money in a pension until age 55 (rising to 57 in 2028).
Make retirement savings your priority
At the end of the day, pensions are primarily about securing your income during retirement.
If you’re relying on your pension for later life, it’s still essential to focus on building and maintaining a healthy retirement fund.
Small actions like upping your pension contributions when you get a pay rise or new job is one way to boost your contributions.
You should also make sure you’re making the most of any contributions your employer is making.
Explore secure income options and life assurance
Another strategy is to use pension pots to buy an annuity, which provides a secure income. This removes capital from the estate immediately.
If your annuity income is more than you need, you could also consider using the surplus to fund a whole of life insurance policy.
These policies are held in trust and offer a guaranteed payout upon death, provided premiums are paid up to that point. This strategy helps to remove money from the estate, which, after April 2027, would otherwise be subject to IHT.
How could this work in practice?
Under IHT rules, a taper reduces the amount of the residence nil rate band (an additional allowance that is generally available when property is left to direct descendants) by £1 for every £2 that the net value of the estate is more than £2mn.
Let’s say you have assets worth £2.7mn (including pension wealth of £1m), by using £700,000 to buy an annuity, that amount is immediately removed from the estate, lowering its value from £2.7mn to £2mn under the proposed rules. This reduction restores access to the residence nil rate band, which further reduces how much of the estate you have to pay tax on.
Impact on inheritance tax
Here’s how the tax liability changes under different scenarios:
Current rules (Before April 2027 – no annuity purchase): 40% of £700,000 = £280,000 IHT
New rules (From April 2027, without action): 40% of £2,050,000 = £820,000 IHT
With the annuity strategy under the proposed rules: 40% of £1,000,000 = £400,000 IHT
There are also other benefits to this strategy. Not only will you reduce your IHT liability by £420,000, but you’ll also benefit from:
A steady income stream from the annuity.
The potential for gifting of income, further reducing the estate's taxable value over time (more on gifting rules in point three).
Any annuity income (after tax) can be used to fund regular premiums for additional life assurance (potentially on whole of life term), held in trust, to pass on additional death benefits outside of the estate as a lump sum.
This approach could make a significant difference in how much tax is owed and supports a broader financial planning strategy.
Consider gifting
Instead of waiting to pass on your pension later, you could start gifting it now. However, how you access your pension benefits can affect your gifting strategy.
You can access your pension in lots of different ways, like an annuity, drawdown, or other flexible options, each with their own implications.
There’s a rule that lets you gift surplus income without it being taxed for inheritance purposes, known as the normal income exemption. This rule applies if the gifts come from your regular income, are habitual, and don’t reduce your standard of living. You should try and keep clear evidence to show this.
If you give a lump sum that exceeds the annual exemption of £3,000, it becomes a ‘potentially exempt transfer,’ which means it will fall outside your estate after seven years.
This can be particularly useful if you use tax-free cash from your pension fund. For example, you could put it into a HL Junior ISA for a child under 18, making sure it’s invested wisely and stays locked in until they turn 18.
However, remember that once you give away money outright, you lose control over how it’s used by the beneficiaries.
The government's free and impartial Pension Wise service can help you and we offer retirement advice if you'd like it.
Our advisers can adjust your financial plan post-Budget. Understand how inheritance tax on pensions and risings capital gains tax could impact you.