With Inheritance Tax on pensions back in the headlines this week, our Managing Director, Phil McGovern FPFS, takes a closer look at the proposed changes and what they could mean for you.

The Government has confirmed that it will proceed with its plans to bring unused pension benefits within the scope of Inheritance Tax (IHT). The change will take effect from 6 April 2027 and is expected to raise an estimated £1.5 billion per year from 2029/30.

Under the new rules, any unused pension funds including personal pensions, SIPPs, occupational money purchase schemes and drawdown plans will be included in IHT calculations. Any amount above the Nil Rate Band (NRB) will be taxed at 40 per cent.

The NRB is currently £325,000 per individual. Married couples or civil partners can inherit each other’s unused NRB, giving a combined allowance of £650,000 on second death. Where a property is owned, the Residence Nil Rate Band (RNRB) of £175,000 per person can also be applied and is inheritable between spouses or civil partners. This means that a couple could potentially benefit from up to £1 million of combined allowances before IHT becomes payable. Any amount above this threshold will be taxed at 40 per cent.

For estates valued at more than £2 million, the RNRB is gradually reduced by £1 for every £2 over the £2 million limit. Once an estate reaches £2.7 million, the maximum combined NRB will fall back to £650,000. For individuals who are single, not legally married or not in a civil partnership, the maximum allowance is £500,000 made up of the NRB plus the RNRB.

Pension funds are often one of the largest assets people hold, so these changes are significant. Government figures suggest that in 2027, around 213,000 estates will inherit pension wealth, with approximately 10,500 of those incurring an IHT bill when previously they would not. In addition, an estimated 38,500 estates will pay more IHT than under the current rules. The average additional tax bill is projected to be £34,000, although these numbers are only estimates and HMRC’s assumptions are not always accurate.

A key change to the original proposal is that responsibility for calculating and paying any IHT due will rest with the estate’s personal representatives, rather than with pension scheme administrators. Executors will need to obtain valuations from all relevant pension schemes to work out the liability and arrange payment. HMRC has said it will provide clear guidance and an online calculator to assist with this process.

Transfers of pension benefits to a surviving spouse or civil partner on death will remain exempt from IHT. The tax will only be triggered on second death.

It is worth remembering that pensions are primarily designed to provide an income in retirement. Careful planning is therefore required to balance your own lifetime needs with the aim of reducing any future IHT liability.

One positive point is that Death in Service life assurance plans will be exempt from IHT. These are schemes that typically pay a multiple of salary if you die while still in employment. There is, however, no mention in the latest update of how annuities will be treated, so it remains unclear whether they will be included in the legislation.

As always, everyone’s situation is different, and we recommend seeking professional advice before making any changes to your financial plans.