People who’ve saved diligently into pensions in the hope that their loved ones would benefit without being hit by Inheritance Tax should now re-evaluate their tax-planning strategies before Budget changes come into effect.
The Chancellor Rachel Reeves announced in the Autumn Budget that pensions for the first time from April 2027 will be brought into scope for Inheritance Tax. This includes both defined contribution benefits being paid as income to a dependant through an annuity or via drawdown and defined benefit pension lump sum death benefits. Making pensions liable for IHT is expected to cost people an eye-watering £1.46 billion in 2029/30.
Under current rules, your pension isn’t usually considered part of your taxable estate on death, although your beneficiaries may have to pay income tax on inherited pension savings if you’re aged 75 or over when you pass away.
Here, we explain what steps pension savers may be able to take to ensure as much of their retirement savings as possible can pass to their heirs rather than the taxman.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
What was announced in the Budget?
From April 2027, if your estate breaches the current Inheritance Tax nil-rate band of £325,000, anything above this amount, including your pension, will be taxed at up to 40% (this is reduced to 36% if you leave at least 10% of your net estate to charitable causes).
That means if, for example, your property is worth £350,000 and your pension is valued at £100,000, and you die in 2028, your loved ones would face a potential £50,000 Inheritance Tax bill (£450,000 – IHT nil-rate band = £125,000 x 40/100 = £50,000). Were you to die in 2026, however, before the changes come into effect, your loved ones’ IHT liability would be £10,000, as the amount over the nil-rate band is £25,000 as pensions are excluded. The nil-rate band has been frozen at £325,000 until 2030.
Not only will your loved ones after April 2027 potentially face a bigger Inheritance Tax bill when you die, but if you pass away after the age of 75 your dependents will have to pay income tax at their marginal rate of income tax on any income they receive from it, in the same way as you would have. This means that they could end up facing a double tax whammy on any pension savings you leave. Find out more in our guide What happens to my pension when I die?
However, money passed to a spouse or civil partner remains completely free from IHT. That means even if you have a pension worth hundreds of thousands of pounds, you can leave it to them and they won’t have to pay Inheritance Tax on it.
Ways to beat the Budget changes
There are several things pension savers can do to try to reduce any Inheritance Tax liability their loved ones might be left facing once the Budget changes come into effect from 2027.
These include:
1) Giving gifts early to protect against Inheritance Tax
There are several annual gifting allowances available, which enable you to make financial gifts free of Inheritance Tax. For example, under current rules, you can give away £3,000 worth of gifts each tax year without them being added to the value of your estate. If you don’t use this annual exemption one year, you can carry it forward to the next tax year.
You can also give as many £250 gifts per person as you want during the tax year, provided you haven’t used another exemption on the same person. So for example, if you’ve given £3,000 to someone this tax year, you can’t then give them a further £250 in the same tax year.
Sarah Coles, head of personal finance at Hargreaves Lansdown said: “Sensible gifts can help support younger family members at a time when you’re still around to see your family enjoy the money. There’s a separate rule that means you can give away surplus income inheritance-tax free too. You need to pay it from your regular monthly income and have to be able to afford the payments after meeting your usual living costs.
“If you give them a lump sum of more than the annual gifting limits, it becomes what’s known as a ‘potentially exempt transfer’, which falls out of your estate after seven years have passed. It also gives you more control over how the money is given. You could, for example, put it into a stocks and shares Junior ISA for a child under 18, so you know the money will be invested carefully, and tied up until they’re an adult.”
Learn more about current IHT git allowances in our article Which gifts are exempt from Inheritance Tax? and about potentially exempt transfers in our guide Inheritance tax: what are potentially exempt transfers.
2) Review your retirement income options
When pensions are no longer shielded from IHT, this is likely to make more people draw down their pensions during their lifetimes, rather than hanging onto them to pass down as an inheritance.
Karen Barrett, chief executive and founder of financial advisory platform Unbiased, said: “While IHT won’t apply until 2027, it could impact how people access their pension and their whole approach to their retirement – especially if they’ve planned based on the current rules.
“For example, retirees often access their pensions last due to its exemption from IHT – but from 2027, doing the opposite could become more popular so loved ones don’t get hit with a steep tax bill. If your estate planning is based on the current IHT rules, it’s a good idea to review this and consider making changes with the help of a financial advisor.”
You can find out about the various different ways to take an income from your pension in our guide What are your pension options at retirement?
3) Explore other ways to save for retirement
Pensions aren’t the only way to save for retirement, and now that they are set to fall into the Inheritance Tax net, you might want to explore different ways to save, which could provide you with greater flexibility when it comes to accessing your savings.
For example, the earliest you can get your hands on your pension savings is 55, rising to 57 from 2028, whereas you can access ISA savings at any time.
Myron Jobson, Senior Personal Finance Analyst at interactive investor, said: “This could lead to a shift in focus towards other tax-efficient savings vehicles, such as ISAs.
“The ISA versus pension debate, therefore, could gain fresh momentum. ISAs offer the advantage of tax-free growth and withdrawals. Pensions, on the other hand, still provide upfront tax relief on contributions and potential for employer contributions, but their appeal may be blunted somewhat by the new Inheritance Tax considerations.”
You can find out more in our article Is it better to save into an ISA or a pension?
If you’re looking to pass money to children or grandchildren, you might want to consider saving into Junior ISA on their behalf. Helen Morrissey of Hargreaves Lansdown said; “You can save up to £9,000 per year into a Junior ISA. Over time, this can play a major part in helping your children onto the property ladder or through university. It can prove a valuable early lesson to your loved one in the power of investment, which can help them feel more comfortable getting more involved themselves. This can also ease any concerns you have that they might fritter it away when they take charge of it at 18.
“Another option is to help them either get on to the property or retirement ladder, by giving them money to contribute to a Lifetime ISA. You can make contributions of up to £4,000 per year and receive a 25% government bonus. The only downside is that if they need to access the money for a reason other than house purchase or retirement, they will be hit with a 25% early access charge.”
Find out more about how Lifetime ISAs work in our guide What are the benefits of a Lifetime ISA? and about how Junior ISAs work in our article Everything you need to know about ISAs.
4) Think about taking out a life insurance policy written in trust
If you’re worried that your loved ones could be left facing hefty IHT charges when you die once pensions are factored into your estate for IHT purposes, you may want to consider taking out a whole-of-life insurance policy to cover any potential inheritance tax bill when you die. You can learn more about life insurance in our guide What are the different types of life insurance?
Writing a policy in trust means that the proceeds can be accessed without probate needing to be granted. The payout won’t be liable for inheritance tax as it falls outside your estate. If you have life insurance already and it isn’t in trust, phone your provider and ask them to send you a trust form.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown said: “You will need to pay a monthly premium which depends on how old you are when you took out the policy and your health, but it could be a great way to give you and your family peace of mind.”
5) Consider downsizing or equity release to give a ‘living inheritance’
Rather than preserving pensions to pass on, you may decide instead to gift some of the value of your home to loved ones either by downsizing or using equity release while also potentially reducing the amount they have to pay in IHT in the future.
Provided you don’t pass away within the next seven years, the gift will be considered to be free from IHT. Read more in our article Which gifts are exempt from inheritance tax? and Can I take money out of my property to give to my children?
Tim Simmons, of over-50s property specialists Regency Living said: ““The recent Autumn Budget has once again put a spotlight on Inheritance Tax and not only have we seen thresholds frozen until 2030, but we’ve also seen the housing market put in a very strong performance so far this year, so it’s understandable that many homeowners may now be more aware of their current position.
“Interestingly, whilst many plan to utilise existing loopholes that allow greater levels of tax relief when passing on an estate to a spouse or child, a greater number are taking a proactive approach by planning to downsize their property.”
If you’re considering equity release, bear in mind that interest compounds over the years and is only repaid when the property is sold, either when you die, or when you move into long term care. This means it can roll up into a substantial sum that could wipe out any savings on inheritance tax made by gifting this money, so it’s essential to seek professional advice to see whether it’s the right option for you. Find out more in our guide Equity release – what is it and how does it work? and How much does equity release cost?
Want to speak to a mortgage advisor? Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage.
If you’re looking for expert mortgage advice, you can get a free consultation with an independent mortgage adviser at Fidelius. Speak with a qualified, FCA-regulated, independent mortgage adviser you can trust. Rated 4.7/5 on VouchedFor from over 1,250 reviews.
A final thought…
Any big change in pension policy provides a good opportunity to review your retirement saving plans, so that you can have peace of mind that your money is working as hard as it possibly can for you, and that you’re ready for any impending changes.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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