Pensions have long been used in succession and Inheritance Tax planning. However, from April 2027, unused pensions will be subject to Inheritance Tax. In this article, we discuss the current position, the changes introduced by the 2024 Budget and the impact on estates from April 2027.

Unused pensions – the current position

Pension funds are currently exempt from Inheritance Tax. This is because they are not included as an asset in the deceased's estate. Trustees hold pension funds on behalf of the individual. The trustees can be instructed to pay the fund to a nominee, or beneficiary, if it has not been converted into an annuity by the pension owner.

When you carry out succession planning, the aim is to pass on as much of your wealth as possible to your loved ones. Pensions have long been a vehicle to achieve this.

Currently, if you die under the age of seventy-five with an unused pension fund, the entire pension pot can be transferred to a beneficiary completely free of tax. If you are over seventy-five when you die, the beneficiary will need to pay Income Tax on the value, at their current tax rate at that time.

It is for this reason that those who are likely to face an Inheritance Tax charge on their overall estate, and who can afford to live off other assets and income, might use their unused pension fund to benefit their loved ones. They deplete their other assets by using them for their living expenses and use the pension fund for inheritance purposes.

Changes from April 2027

However, from April 2027, unused pension funds will be included in an estate for Inheritance Tax purposes. It is proposed that pension scheme administrators will become liable for reporting and paying any Inheritance Tax due to HMRC when notified of the pension holder’s death.

In addition, should the pension fund holder be over seventy-five years of age, not only will Income Tax based on the beneficiary’s Income Tax rate at that time be payable on the fund, but also Inheritance Tax.

What does this mean for estate planning in the future?

The closure of this avenue of Inheritance Tax avoidance is impactful for those who were planning to leave their unused tax-free pension fund to their beneficiaries. Of course, there remains no Inheritance Tax between spouses or civil partners. On the other hand, transferring your entire estate to your spouse or civil partner might store up future Inheritance Tax problems for them.

Some believe that the new rules will encourage people to draw down their pension funds, either through income drawdown or annuities, while transferring other assets to their beneficiaries using available exemptions and gift allowances.

Succession and Estate Planning Solicitors, North Berwick and Dunbar, East Lothian

Succession and estate planning can be immensely complicated. We recommend that you take professional legal and financial advice to help decide the most effective benefits to you and your loved ones.

The solicitors at Paris Steele have a wealth of experience helping clients with their succession and estate planning challenges. If you would like to discuss how we can help, or if you wish to make or update your Will, please get in touch with us.