Pensions and IHT

From April 2027, unless the Government changes it mind, the value of your personal pension will form part of your estate when you die.

Currently, many people use their personal pension as a way to protect their investments from Inheritance Tax. Unfortunately this is set to change.

At the moment it is possible for a couple who own their £1mn home, have children and each have a £1mn pension pot to avoid IHT, even though they are worth £3mn. From April 2027 the situation will get markedly worse as the pension will form part of the estate increasingly the IHT bill massively. And it gets worse than first thought.

Currently if you die before 75, your pension is available to your beneficiary free of capital gains and income tax. However, if you die after 75, the recipients of your pension will pay income tax on any money they receive from your pension. Whilst you are alive, you pay income tax on your pension income too, so this is fair enough.

However, with the new rules, IHT will be taken too. So if you were already above the IHT tax-free level, if you died with a £600,000 pension, the government would take £240,000 of IHT, leaving £360,000 for your children. If you were over 75 when you die, they would pay income tax, so if you children were higher-rate tax-payers, they would pay a further £144,000 of income tax. So of your original £600,000, they would only get £216,000. Ouch!

However, some positives. IHT is always paid on second death (if you are married) so your widow would not have to find any money when you die. Secondly, most people will reduce their pension pot during their retirement by taking income and ticking off their bucket list. So you would be spending your way out of the problem. And if the Conservatives/Reform get back into power in 2029, they most probably will change things back to the current arrangements.

Also, it is important to remember that IHT will only be payable on your pension pot if your total estate exceeds the tax-free threshold. So if you are married with kids, have a £600,000 house and a £400,000 personal pension pot when you die, you would not pay any IHT.

If you are single, and have neither a home nor a child to leave it too, your tax-free limit (Nil Rate band) is only £325,000 so if your pension, when added to the value of your house exceeds £325,000, you will pay 40% IHT on the excess.

In the meantime, it is possible that investor behaviour may change. A personal pension is still the best retirement savings vehicle for most people, especially if they are higher rate tax-payers. So stopping pension contributions would lead to very poor outcomes. However, whereas now we encourage our clients to take income from their other assets BEFORE touching their pensions,it might be the other way round but only if IHT was likely to be an issue.

So basically, individual financial advice will be even more important than it is now.

More News, Insight & Opinion