From April 2027, pensions are expected to fall within your estate and could be liable for Inheritance Tax (IHT). That date might seem far away, but the policy change has the potential to significantly affect your estate plan, so thinking about it now could be useful.
While the policy change is still in the initial stage, the government has signalled that it intends to move forward with the plans.
Under current rules, your pension usually falls outside of your estate when calculating a potential IHT bill. As a result, pensions are often used in tax-efficient strategies to pass on wealth to loved ones.
The inclusion of pensions may mean some estates might need to consider IHT for the first time, or that estate plans need to be updated.
In 2025/26, the nil-rate band is £325,000. If the total value of all your assets, including your pension from April 2027, exceeds this threshold, your estate may be liable for IHT.
The good news is that there are often steps you can take to reduce an IHT bill, which an estate plan could help you identify.
Most pensions are set to be liable for Inheritance Tax, but there are some exceptions
The current proposals suggest most pensions are set to fall within the IHT net from April 2027, including defined contribution pensions, defined benefit pots, workplace pensions, personal pensions, and self-invested personal pensions.
However, there are some exceptions, including pensions that provide an income during your retirement years and certain types of annuities.
In addition, if your pension has a death in service benefit, which may provide your spouse, civil partner, or dependent children with a lump sum or regular income if you pass away, this is expected to be outside of your estate for IHT purposes.
Under current rules, beneficiaries don’t usually pay IHT on inherited pensions, but they may pay Income Tax in some circumstances. Assuming this doesn’t change, it could mean inherited pensions are subject to double taxation as they’ll be liable for both IHT and Income Tax.
The changes could significantly reduce how much you leave behind for loved ones, and could mean that passing on wealth through a pension no longer makes sense from a tax perspective.
3 ways you could pass on wealth and reduce Inheritance Tax
If you’d previously planned to use other assets to fund your retirement so you could pass on your pension tax-efficiently, your wider financial plan may need to change as a result of the incoming policy.
For example, you might choose to deplete your pension during your lifetime and pass on different assets to loved ones now or in the future. Here are three alternative options you might want to consider.
1. Gift assets to loved ones during your lifetime
One option is to pass on assets now. This could provide support for your loved ones when they need it most, such as when they’re buying their first home or are paying a child’s school fees.
However, there are two key things to be aware of before you start gifting assets.
First, review your financial plan to ensure you’ll still be financially secure in the long term after gifting assets.
Second, not all gifts are immediately outside of your estate for IHT purposes. Some may be considered part of your estate for up to seven years after they were gifted; these are known as “potentially exempt transfers”.
Gifts that are immediately considered outside of your estate include:
- Up to £3,000 each tax year
- Small gifts of up to £250 per person each tax year, so long as you have not used another allowance on the same person
- A wedding gift of up to £1,000, rising to £2,500 for grandchildren or great-grandchildren and £5,000 for children
- Regular payments to another person that are from your regular monthly income. For example, you may pay into a savings account for a child or cover the rent of an elderly relative.
So, you might want to make gifting part of your financial plan to make the most of gifts that are immediately exempt from IHT.
2. Place assets in a trust
A trust is a legal arrangement where assets are held on behalf of beneficiaries. For IHT purposes, you may use a trust to remove some assets from your estate. In some cases, you might still retain control or benefit from the assets.
There are several different types of trust, and it’s important to ensure yours is set up correctly, as it may not be possible to retrieve assets once they have been placed in a trust. Seeking professional legal and financial advice could help you assess if a trust is the right option for you before you proceed.
3. Take out life insurance to cover an Inheritance Tax bill
A life insurance policy won’t reduce the amount of IHT your estate is liable for, but it can provide your loved ones with a way to pay the bill.
You’ll need to pay regular premiums to maintain the cover. When you pass away, your nominated beneficiary will receive a lump sum, which they can then use to pay the IHT due. It could reduce stress for your loved one at a difficult time and help ensure your estate is passed on intact.
It’s important that the life insurance is written in trust. Otherwise, the payout could be considered part of your estate and lead to a larger IHT bill.
Get in touch to talk about your estate plan
Whether you’re starting from scratch or have an existing estate plan that you’d like to review, we can help you assess what the upcoming changes mean for you and the legacy you want to leave behind. We can work with you on an ongoing basis to ensure your estate and wider financial plan continues to reflect current policy and your needs. Please get in touch to talk to us.
Please note: This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.
HM Revenue and Customs’ practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
The Financial Conduct Authority does not regulate Inheritance Tax planning or trusts.
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