From exempt to exposed: April 2027 pension and IHT changes – Your questions answered

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Currently, pensions are exempt from assessment to IHT. This, coupled with the flexibility options that were introduced in 2015 have seen pensions increasingly used as a means of transferring wealth on death.

From 6 April 2027, most unused pension funds and death benefits will be included in the value of a person’s estate for inheritance tax (IHT) purposes. This change is designed to discourage the use of pensions as a wealth transfer tool and encourage their use for retirement.

Below are answers to the most common questions advisers are asking:

1. What’s the best way to reduce pension IHT exposure?

There’s no universal solution, every client will have unique circumstances. Balancing IHT exposure, with income tax exposure is key. Popular estate planning strategies include lifetime gifting, using life assurance and using exemptions; Advisers should tailor strategies with these factors in mind:

• Think about the entire estate. Pensions will form part of wider wealth transfer planning, consider all estate assets, not just pensions when planning for the additional IHT liability.
• Client goals: for example, if a client wants to leave a lump sum legacy, annuitisation may not be the best course of action.
• Client and beneficiary tax position: pension income and certain pension death benefits are subject to income tax. Increased income tax exposure may offset IHT savings.
• When to act:  Age 75 represents a cliff edge where most pension death benefits transition from being income tax free to fully exposed to income tax. Do clients have time and ability to replan their wealth transfer considering April 2027 changes without jeopardising IHT plans if death happens before April 2027? 
• Beneficiaries could also have IHT liabilities: Consider directing benefits to grandchildren rather than concentrating assets with children, to help reduce cumulative IHT exposure across generations.
• Fund choices: If your client’s pension is no longer a vehicle for wealth transfer, is it being repurposed for income or lower growth? Are the fund choices still appropriate? 

2. Is there an impact on the Residence Nil Rate Band (RNRB)?

Yes, pension death benefits will be included in the estate valuation. This could push the total estate value above the £2 million threshold where the RNRB is tapered at £1 for every £2 over the threshold. The RNRB is lost completely at £2.35 million (£2.7 million for estates with an inherited RNRB).

 

Example: Susan has inherited NRB and RNRB with £2m of other estate assets, with a pension valued at £700,000. What is her IHT position now and after April 2027?

	Pre April 2027	Post April 2027
Total Estate	£2,000,000	£2,700,000
NRB	£650,000	£650,000
RNRB	£350,000	£0.00
Total NRB	£1,000,000	£650,000
Total taxable estate	£1,000,000	£2,050,000
Total IHT	£400,000	£820,000

Implications for clients:

• Estates previously under the threshold may from April 2027 exceed it due to pension inclusion.
• Any gift made by the client immediately reduces the estate for the purposes of the RNRB taper. Planning, such as gifting, or annuitisation if the pension is to be used as a source of income can be immediately effective to regain this valuable IHT band.

3. Can annuities help reduce estate values for IHT purposes?

Yes, annuities can certainly be used to reduce the value of the estate and guarantee a regular income for life. This can be useful for some clients and using annuities for everyday income can help you to realign other assets for estate planning.

Advisers should ensure purchasing an annuity aligns with a wider income tax and wealth transfer strategy. There are a number of advantages and disadvantages to consider.

Advantages of annuities:

• The purchase price is removed from the estate immediately.
• Provides predictable income and supports structured gifting (for example, gifts from normal expenditure).
• Annuity options can be tailored for client needs.
• Joint life annuities will be exempt from assessment to IHT.

Disadvantages:

• Purchasing an annuity could result in fewer benefits than expected if your client dies early, unless annuity protection is purchased.
• Limited flexibility if client circumstances change.
• Higher and additional rate taxpayers may face income tax rates that offset IHT savings.
• Annuity protection and guaranteed periods remain within IHT scope.

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4. Will defined benefit (DB) schemes be affected?

Yes, both DB and defined contribution (DC) schemes are impacted, though as these schemes usually offer different death benefits there are some practical differences. For DB schemes the following will be included in IHT assessments:

• DB lump sum death benefits.
• Pension protection lump sums.
• Certain death in service payments for those no longer employed.

Excluded from IHT:

• Death-in-service benefits if the member was actively employed.
• Dependants’ scheme pensions (for example. spouse pensions from DB schemes).
• Trivial commutation lump sums paid from a dependant’s scheme pension

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5. Should clients access tax-free cash now to reduce their estate?

Understanding client needs and total assets will play a big role determining when to access tax-free cash. Accessing the lump sum earlier allows more time for the lump sum to be gifted and then be fully outside of your estate after 7 years. You also need to consider the income tax implications on death before and after age 75.

Before age 75:

• Most death benefits remain income tax-free (except for scheme pensions).
• Leaving funds in the pension allows continued tax-free growth.

After age 75:

• Death benefits are subject to income tax and IHT.
• Taking tax-free cash may help reduce taxable estate and reduce assets subject to income tax.

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Summary

These changes represent a significant shift in pension and estate planning. Advisers should proactively review client portfolios, update nominations, and consider strategic use of annuities, drawdown and gifting to mitigate IHT exposure.

For further information and queries, please call one of our distribution team today, or refer to our TechVoice resources.

Watch our recent webinar

If you’d like more in depth information on the pensions and IHT changes, and what this means for you and your clients, watch our recent Pensions and IHT webinar.