how does new rules to IHT affect my pensions

The world of pensions is completely changing moving forwards as they will now become part of your estate for Inheritance Tax purposes (IHT). 

Previously, any funds held within a pension product or wrapper was considered exempt.

So it was one of the most tax-efficient investment products available.

In the 2024, Autumn Budget statement, Rachel Reeves announced proposed changes to the way that pension benefits are treated for IHT purposes. being effective from 6th April 2027.

What current rules apply !

Under current rules, most pension schemes are usually excluded form the value of their estate. 

Although, in some circumstances IHT could apply if they are non-discretionary trusts (not written in trust) such as:

• the member chooses or nominates the beneficiary, rather than the discretion of the scheme trustees.
• death benefits paid from a retirement annuity contract (RAC) or section 32 (S32) plan, unless the benefits are held in trust.
• The member is in ill-health, and transfers benefits from one scheme to another and dies within 2 years of the transfer.

So what exactly is changing

From 6 April 2027, most unused pension funds and death benefits will be included in the
value of a deceased person’s estate for Inheritance Tax (IHT) purposes.

This major change removes the long-standing IHT exemption for pension pots, meaning your
beneficiaries could face a 40% tax charge on the value above the standard £325,000 threshold, alongside potential income tax when they withdraw the money.

For most people who have relatively small pots through the recent introduction of Auto-enrolment since 2012.

It may not be a problem or consideration, but it may be an issue if you have other savings or investments held within an ISA or investment account, premium bonds or you own a substantial property.

It could quite easily be that your total estate is in excess of the current IHT thresholds mentioned.

At present, everyone has allowances:

Nil rate band (NRB): £ 325,000

Residence Nil-rate band (RNRB): £ 175,000 (if you pass your home  onto your children or grandchildren)

So combined allowance:  £ 500,000 or £ 1,000,000 if a couple being fully transferrable

Taper allowance: £ 2 million, which reduces by £ 1 for every £ 2 the estate exceeds this level.

At present these rates are frozen until April 2031. Although they may change in future through budget announcements. 

In the past it was generally seen that spending other assets held within back account, savings, Isa etc, was the first thing to access as part of your estate planning.

You would then leave your pensions invested within a IHT free wrapper, so in a worst case scenario they could be passed onto family members IHT free and possibly income tax -free. (dependant on the age you die)

So what are the key changes !

• Any undrawn funds held within a DC pension, will form part of your estate.
• Pension funds left to a spouse will remain IHT free.
• Death is service benefits and spouse’s pensions from certain DB pensions are exempt
• Family members and executors will be responsible for informing HMRC and paying any IHT fees. (not the pension provider)

So what rates of IHT are payable !

IHT will be applicable to 40% on any figure in excess of your allowances as attend above.

The sum is due to be payable to HMRC within 6 months after the end of the month. In which stated person died, regardless of probate being granted.

If the payment isn’t made then interest rate charges apply from the day after the initial due date. 

See gov.uk for more information of rates of % applicable.

So which types are pensions are affected !

I.e pensions being paid to non- spouse, or civil partner.

Being included (in scope):

• funds being held in drawdown (FAD)
• nominee or successor drawdown account
• lump sum death benefit payment
• successor annuity plan
• annuity protection lump sum death benefit.

Not included in scope:

• death benefits paid to spouse/civil partner or a charity
• death in service benefits
• joint life annuities
• nominees annuity
• dependants scheme pension (DB pension to spouse)
• trivial commutation of a dependant’s pension

So how does somebody pay IHT taxes !

The idea is to introduce 3 proposed options or strategies. When paying IHT under the new rules from April 2027.

• It can be paid directly from the estate, whereby the complete IHT liability can be paid. It can be done prior to probate application.
• You could ask the pension scheme to pay on your behalf. If over £ 1,000 or more. The pension scheme can pay lower amounts on discretion. But they must settle the amount within 35 days of receiving such request.
• The scheme could pay the beneficiaries directly, who then pay HMRC or LPR directly. If the deceased was over age 75, then they could request a refund of any overpaid income tax due.

What about income tax !

Below age 75:

At present if somebody dies below age 75, then the beneficiary will receive the remaining funds in drawdown. Or regular income in the form of an annuity completely tax-free as long as they act within the 2-year rule.  If they fail to act within that timeframe, any income tax payable would be taxed at the beneficiaries marginal rate at point of access.

Aged over 75:

If the policyholder dies over age 75, then irrespective of timeframe. The beneficiary could revive the refining funds via drawdown (FAD), or annuity income.

But it would be subject to income tax applicable to the. beneficiaries marginal rate. As it would be added to any other earnings they receive during that respective tax year.

So be aware !

It somebody dies over age 75, then the beneficiary could be hit with a double tax blow,

IHT at 40%, plus income tax at the beneficiaries marginal rate.

In recent years the idea of buying an annuity has fallen out of favour. Mainly due to rates payable being relatively low as they are linked to bank interest rates.

However though, in recent years the purchasing of annuities has increased substantially as rates have been increased and now stand at 3.75% (as per July 2026) 

The sale of annuities could be increased dramatically due to the proposed new IHT rules. 

Because if you purchase an annuity, you have in effect spent that money and it no longer sits within your estate. So in return you receive a guaranteed level of income from that annuity provider.

If this option sounds appealing get some figures form your pension provider, or use a hub, broker, comparisons tool, IFA etc to assist you.

Or check out my blog post on annuities for greater information being: https://moneyminted.co.uk/what-is-an-annuity

But remember, don’t buy a products for tax purposes. Buy a product because you need addition income in retirement.

For an annuity you get security and a guaranteed income.

For drawdown, you pot is still invested and subject to ongoing investment risk, But you have flexibility about how you manage and access that pot on your terms until it is empty.

Remember:

If you found this blog post useful and informative check out my other pots on pensions, savings and investing on https://moneyminted.co.uk