From 6 April 2027, with some exceptions, savings held in registered pension schemes will be included in the value of an individual’s estate when calculating inheritance tax (IHT). What steps can you take now to mitigate the extra tax?
Time to plan
Currently, the government is consulting on its Budget proposal to bring savings in registered pension schemes within the scope of inheritance tax (IHT) with effect from 6 April 2027. Bearing this in mind you should consider the general rule of thumb for IHT planning, which is to give away as much as you can as soon as you can.
Planning strategies
The type of IHT planning you can do will depend on whether you’re drawing, or are entitled to draw, on your pension savings (generally, if you’re 55 or older).
In this article, we look at planning if you have savings in a money-purchase pension plan which you’re old enough to access.
How much is at stake?
The effect of IHT on your pension savings isn’t as simple as your estate having to hand over 40% of it to HMRC. For many estates, there will be no extra tax at all. Others will have to pay IHT for some or all pension savings.
Where IHT applies, it reduces the residual savings for your beneficiaries, who will then have to pay income tax on the money they receive.
For beneficiaries who pay tax, combined extra IHT/income tax compared to the current position will be 32% for basic rate taxpayers, 24% for higher rate taxpayers and 22% for additional rate taxpayers
Both now and after pension savings come within the scope of IHT, the easiest way to reduce the tax is to make gifts at least equal to your annual IHT exemption. While this is effective it doesn’t have much impact as the exemption is just £3,000. You can make larger gifts but these only become fully IHT exempt if you survive at least seven years from the gift date.
Tip. Drawing on your pension savings to fund larger gifts can reduce the impact of IHT after 5 April 2027. These can be IHT exempt from the date you make them because of the “normal expenditure out of income” exemption, also known as the s.21 exemption.
Example.
Harry is 68 and unmarried; he has two sons who are the beneficiaries of his estate. His general estate, including his home, is worth £800,000 and his pension savings, £450,000. He currently draws £26,000 of these per year from his pension pot which when added to his state pension meet his needs. If Harry dies in 2032 the value of his general estate and pension fund will have grown to £1,320,000. After deducting the IHT nil rate band (NRB) and residence NRB, £820,000 of his estate is liable to IHT. Had Harry taken an extra £20,000 per year from his pension savings and given the net tax amount away to his sons it would have reduced his estate on which IHT was payable by £160,000. Assuming Harry was a basic rate taxpayer this could increase the amount his sons would inherit by £59,200, i.e. £370 for every £1,000 gifted.
Consider drawing extra money from your pension fund on a regular basis and giving it away to those who are your beneficiaries. The gifts are immediately exempt from IHT. This can increase the amount your beneficiaries receive by £370 for every £1,000 you give away compared with if you had left the money in your pension fund.