The UK government recently announced that from April 2027, inherited pension pots will face new inheritance tax (IHT) regulations, marking a significant shift in estate planning strategies for pension holders. For many high-net-worth individuals (HNWIs), this change could impact their retirement and legacy plans. Here, we break down the key changes and explore strategies to help protect your wealth for future generations.
Understanding the New Pension Inheritance Tax Landscape
Traditionally, pensions have been an efficient way to pass wealth to the next generation without triggering IHT. However, under the new rules, pension funds will be included in estates for IHT purposes, with a 40% tax rate applied to estates exceeding the £325,000 threshold.
- Impact on Families: If you leave your pension to beneficiaries after age 75, they may face both IHT and income tax, potentially resulting in an effective tax rate of up to 67%. For many, this will lead to significantly higher tax liabilities on inherited pension assets.
Potential Financial Impact and ‘Double Taxation’ Concerns
The inclusion of pensions in IHT calculations introduces a “double taxation” effect:
- Beneficiaries of pensions inherited after age 75 already pay income tax on withdrawals.
- Now, from April 2027, IHT will apply first, followed by income tax on the inherited amount, which could erode the value passed down significantly.
For estates with significant pension assets, this change could increase IHT liabilities by 15-20% or more. Planning ahead is essential to mitigate these potential costs.
Should You Empty Your Pension? Pros and Cons
Some may consider withdrawing funds from their pension to avoid future IHT. While taking the tax-free 25% lump sum can be appealing, there are caveats:
- Loss of Compound Growth: Withdrawing early limits the potential for compounding and investment growth, which may reduce the value of your estate.
- Tax Efficiency: Pensions are generally tax-efficient vehicles, so withdrawing large sums could incur significant income tax charges if withdrawals exceed the higher-rate tax threshold.
Expert Insight: For those with substantial pension funds, taking early withdrawals to gift to family or invest in alternative vehicles may be worthwhile, but should be balanced with the potential for investment growth and personal income needs.
Lifetime Gifting: A Viable Strategy for Reducing IHT
Another approach to managing future IHT liabilities is lifetime gifting:
- Annual Allowances: You can give up to £3,000 per year tax-free, and additional allowances apply for wedding gifts and other specific cases.
- Seven-Year Rule: Larger gifts are exempt from IHT if you live for seven years after making the gift.
While gifting can reduce IHT, it’s crucial to ensure you retain enough assets to cover your own long-term needs, including potential care costs in later years.
Trusts: Structuring Wealth for Future Generations
Trusts remain a powerful tool for estate planning:
- Bare Trusts: Allow assets to be given to younger generations tax-free if you live for seven years post-gifting.
- Discretionary Trusts: Offer more control but are subject to 20% IHT on amounts over £325,000 and a 6% charge every ten years.
Consideration: Trusts can be complex and come with their own administrative costs, so professional advice is essential.
Life Insurance: Mitigating IHT Liabilities
Taking out a life insurance policy to cover future IHT bills can help beneficiaries avoid the financial burden:
- Whole of Life Insurance: Can cover anticipated IHT liabilities, providing a tax-free payout for beneficiaries.
- Policy in Trust: Placing life insurance in trust ensures the payout is separate from the estate, keeping it outside IHT calculations.
Cost Implications: Life insurance premiums vary depending on age and health, and getting coverage early can be more cost-effective.
Preparing for Increased Administrative Complexity
The new regulations will likely introduce more administrative challenges:
- Executors will be required to contact pension providers, who will calculate and pay their share of the IHT bill.
- Any delays in processing pension information could postpone the overall settlement of the estate, affecting beneficiaries.
Plan Ahead: To ease the burden on your family, ensure all relevant information is well-documented, and keep clear records of pension details, trusts, and gifting.
Why Now is the Time to Rethink Your Retirement Strategy
With these changes on the horizon, it’s essential to review your pension and estate planning strategies to ensure they align with the upcoming rules. Blacktower’s team of financial advisors can provide guidance on how to adjust your financial plans to minimise IHT liabilities, maximise the value of your pension, and ensure a secure legacy for your loved ones.
Contact us today to schedule a consultation and explore strategies to protect your wealth from increased IHT, while ensuring your financial needs are met for the future.
Estate Planning, Inheritance Tax Planning and Tax Planning are not regulated by the Financial Conduct Authority. The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
This communication is for informational purposes only and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.