Understanding the New UK Inheritance Tax (IHT) Rules for Pensions
https://inheritance-tax.co.uk/understanding-the-new-uk-iht-rules/
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In the Autumn Budget 2024, Chancellor Rachel Reeves introduced significant changes to Inheritance Tax (IHT) on pensions, impacting UK-registered pension schemes and Qualifying Non-UK Pension Schemes (QNUPS). Starting April 6, 2027, these reforms aim to bring pensions in line with other inheritance assets, eliminating the tax advantage pensions have held for wealth transfer. For pension holders and beneficiaries, these changes call for a re-evaluation of estate planning and retirement strategies.
Key Changes to Inheritance Tax Rules UK and Pensions
Historically, pensions have been excluded from IHT calculations, making them a popular tool for wealth transfer. However, the 2024 Budget changes mean that most unused pension funds and death benefits will now be included in a person’s estate, making them potentially subject to a 40% IHT rate on amounts above the current nil-rate band of £325,000. Here are the primary changes:
- Inclusion of Unused Pension Funds in Estates: Any pension funds left untouched at death will be included in the estate value, subject to IHT. This change will affect the inheritance tax threshold in the UK, especially for larger estates.
- Reporting and Payment by Pension Scheme Administrators (PSAs): For the first time, PSAs must report unused pension assets and pay IHT directly to HMRC, lifting this burden from the deceased’s personal representatives (PRs).
- End of Discretionary Pension Exemptions: Previously, discretionary pensions could avoid IHT, but this will no longer be the case. Discretionary and non-discretionary pensions will now be fully included in estate valuations.
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Why Are These Changes Being Made?
The government, under Rachel Reeves, states that these reforms create a fairer system for IHT application. The 2015 pension freedoms and the 2023 abolishment of the Lifetime Allowance increased the popularity of pensions as inheritance vehicles. By including pensions in IHT calculations, the government aims to make pensions consistent with other inherited assets.
These changes align with Labour’s broader stance on tax fairness, seen in the Rachel Reeves budget and Labour inheritance tax rules, which emphasise closing tax loopholes and ensuring taxes reflect wealth distribution fairly.
How Will the New IHT Rules for Pensions Work?
Starting in April 2027, PSAs will take on new responsibilities, including:
- Reporting and Paying IHT on Unused Pension Funds: When a pension member passes away, PSAs must assess any unused pension assets, calculate the IHT, and report it to HMRC. This process includes liaising with PRs to ensure accurate IHT calculations across the estate.
- Coordination with PRs: PRs must notify PSAs about nil-rate band allocations and work together to accurately assess IHT for the estate.
Implications for Estate Planning
For those planning to pass on substantial assets, including pensions, the changes may result in higher IHT liabilities. The government estimates that around 10,500 estates will become IHT-liable in 2027-28 due to these reforms. Key considerations for pension scheme members and beneficiaries include:
- Revaluating Drawdown Strategies: Pension holders might consider drawing down pension funds earlier to reduce the estate’s taxable value.
- Exploring IHT-Efficient Investments: With pensions now less tax-efficient for inheritance, other assets that qualify for Business Property Relief or Agricultural Property Relief may become more attractive.
- Gifting Wealth: Lifetime gifting, supported by the 7-year inheritance tax rule, remains a viable strategy to reduce estate value, provided gifts are made well in advance of death.
Potential Tax Scenarios Under the New Rules
The government has provided case studies to illustrate the effects on estates with substantial pension funds:
- Increased IHT on Larger Estates: For example, a £1.5 million estate that includes a £700,000 pension would be subject to a 40% IHT rate after applying the nil-rate band.
- Impact on Death Benefits: A £200,000 lump sum death benefit from a defined benefit scheme will now be added to the estate value, which could increase the IHT due.
- Spouse/Civil Partner Exemptions: Transfers to a spouse or civil partner will remain exempt from IHT, consistent with other assets benefiting from marital exemptions.
Administrative and Financial Implications
These changes will require PSAs to update systems and processes to handle new reporting requirements. HMRC will also implement updates to the Accounting for Tax (AFT) return system, enabling PSAs to declare IHT liabilities on pension death benefits digitally.
Planning for 2027 and Beyond
To prepare for these IHT changes, individuals and families should consider revising estate plans now to adapt to Labour’s inheritance tax rules and the updated IHT treatment of pensions. Key strategies to consider include:
- Alternative Savings Options: Other tax-efficient assets, such as those qualifying for Private Residence Relief, may offer better IHT advantages than pensions.
- Drawdown Strategies: Adjusting pension drawdown frequency could reduce the estate’s exposure to IHT under the new rules.
- Lifetime Gifting: The IHT-free 7-year rule allows individuals to reduce estate size through advance gifts, which can mitigate IHT liability if given in time.
Key Takeaways
The 2024 Autumn Budget represents a shift in how pensions are viewed for IHT, with Rachel Reeves’ budget aiming to close loopholes and align pensions with other inherited assets. These reforms underscore the importance of proactive estate planning to meet the evolving IHT landscape. To learn more about navigating these changes, reach out to our team at inheritance-tax.co.uk or call us directly on 0207 183 0136.
By staying informed about Labour’s inheritance tax changes, capital gains tax adjustments, and other evolving tax policies, you can ensure your estate planning remains aligned with both your retirement and legacy goals.
https://inheritance-tax.co.uk/understanding-the-new-uk-iht-rules/
