Following the Autumn Budget, unused pension schemes will attract Inheritance Tax on death from 6 April 2027. Craig Simpson, Tax Partner at Bates Weston looks at the changes and the impact on the tax burden on your estate and beneficiaries.
What changes are expected to Inheritance tax and pensions?
One of the unpopular tax changes in the Labour Budget 2024 was the announcement that unused pension schemes will attract Inheritance Tax on death from 6 April 2027. More detail is to follow from the treasury as to exactly how this will work but the announcement itself has rightly alarmed many who have been adopting a pension saving strategy as part of their overall retirement plan.
This move will also impact the final salary (defined benefit “DB”) schemes of the public sector although probably only the death benefits paid prior to the drawing of a pension. Ultimately DB schemes are a promise to pay a pension based on a calculation linked to the salary. It is funded globally by the scheme and so once the DB pension is drawn down it will not have a value on death.
The change will though impact on anyone with a usual defined contribution plan, i.e. a savings based pension like a stakeholder, SSIP or SSAS. This is the vast majority of the private business sector.
How much tax could my estate and beneficiaries have to pay?
Based on the consultation document we currently understand that the value of the unused pension will be added to an individual’s estate. This is for IHT purposes only though, as if the individual dies after age 75 then IHT will be levied first at 40% (assuming IHT is payable by the estate) and then if the remaining beneficiaries of the scheme withdraw the pension, they will pay income tax at their marginal rate which could be as high as 45%. That is a very high marginal rate of tax on the pension scheme value.
If the individual dies and leaves the unused pension to their spouse then no IHT will be levied on the first death. This mirrors the current IHT exemption for inter spousal transfer of assets.
A change in pension policy?
This is a significant change to pension policy. Prior to the announcement there seemed to be a recognition that in order to tackle the unsustainable burden of the state pension, the concept of succession in pension planning was an attractive solution. The amount that could be put into pensions had been restricted on the basis that on death they could pass the pot down to the next generation, thus over a few generations the reliance on the state would be reduced. This change is squeezing both ends of the pot, with the amount that can be saved being restricted and the value at the end also being taxed.
It is perhaps no surprise that comments from clients are not entirely positive. However, it worth noting that pension saving is still an attractive proposition in terms of the tax reliefs available on contributions and the tax free environment in which the investments grow. It is still worth having a pension as part of the overall plan.
There is no doubt scheme administrators will have to consider pension scheme liquidity, particularly where property is owned within the scheme. The IHT will be payable 6 months after death and so having some available cash to meet the liability will be an important factor.
Overall this was not an entirely positive announcement by Rachel Reeves, but although changes were made to the taxation of unused pension pots, the contribution limits and tax reliefs on paying money in and investing have remained unchanged.
As always, you are reminded that this article is generic in nature and you should take no action based upon it without consulting your professional advisor.