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Pension and inheritance tax reform explained. Are you prepared?
By Stephen Rankine, Financial Adviser, Blevins Franks
Significant changes are on the horizon for UK pensions and estate planning. Pension funds will soon be included in your estate for UK inheritance tax purposes – a reform that could dramatically increase the tax burden on your heirs. Are you prepared?
Historically, UK pension funds have generally been exempted from UK inheritance tax (IHT) when passed on to beneficiaries – but this is changing. From April 2027, any unused funds and death benefits will form part of your estate for IHT purposes.
This reform is expected to impact hundreds of thousands of British families. Expatriates are also affected, regardless of how long they’ve lived abroad.
How does this impact your family? A case study
How much more tax will your children pay? Here we look at a typical British expatriate couple living in Portugal (though it also applies to other countries as well as UK residents).
John and Jenny moved from the UK to Portugal in 2023 when John retired. They opted to keep their £500,000 UK property, which had been their family home since the children were young, as they visit a few times a year to spend time with family and friends. They would also like to leave it to their daughter eventually.
They used some of their savings to buy their new Portuguese home, worth £350,000, and left the £260,000 balance invested in the UK. John also has a Self-Invested Pension Fund (SIPP) worth £720,000.
At present, their total estate liable to inheritance tax is £1,110,000 since John’s SIPP is excluded. Their combined nil rate bands (personal and residential) amount to £1,000,000, so their taxable estate is £110,000.
Today, with pensions excluded, their tax liability is £44,000.
However, from April 2027, their financial situation will change significantly.
John’s £720,000 SIPP will be added to their estate, bringing the total value to £1,830,000. Their IHT allowances, however, remain at £1,000,000.
In 2027, with pensions included, the resulting IHT liability is £332,000 – a 655% increase.
If this resonates with you, act now to protect your family and heirs. Seek specialist cross-border integrated pensions and tax advice to explore potential solutions.
This case study is for illustrative purposes only and has been simplified.
Other pension taxes on death
When the balance of your pension fund passes to your beneficiaries, they may face income tax at their marginal rate (up to 45%) as well as the 40% inheritance tax.
If your beneficiaries take the death benefits as a lump sum, any amount over £1,073,100 (or lower if you previously took other lump sums), will be taxable regardless of your age of death.
If they take the benefit as pension income, they will pay income tax if you die after age 75, but zero income tax if you die younger than this.
Calculating your IHT liability
UK inheritance tax, which can also apply to lifetime gifts, is calculated and charged on your worldwide estate. This includes all property, bank accounts, investments, insurance policies not in trust, household contents, jewellery, vehicles etc – with pensions having been a key exemption until now. Outstanding loans are deducted from the total. Transfers to spouses and civil partners are generally exempt (unless the transfer is from a long-term resident spouse to a non-long-term resident spouse, in which case there are restrictions to the spousal exemption).
Once your estate exceeds the £325,000 threshold, IHT is generally applied at 40%. The ‘residential nil-rate band’ (RNRB) can provide an extra £175,000 allowance for a main home left directly to descendants, though it is tapered down to zero for estates valued over £2 million. Any unused nil-rate bands on the first death can be transferred to your spouse/civil partner, potentially giving you a total £1,000,000 allowance on the second death.
While tax thresholds should rise with inflation, the main allowance has been frozen since 2009 and the residential one since 2021, which can have the same effect as cutting them. Both allowances will remain frozen until at least 2030 – three years after pensions are included.
UK inheritance tax, long-term residence and expatriates
The abolition of the domicile regime was a welcome reform for expatriates. The replacement long-term residence rules not only provide more clarity for inheritance tax, but many more families will now only be liable on UK-situated assets and not on worldwide wealth as previously.
UK pension funds, though, are of course UK assets. Unless you are in a position to move your funds overseas, the 2027 reform could have significant implications for your estate.
Protect your family – act now
Whether you live in the UK or overseas, now is the time to establish exactly how your family will be affected and if there is anything you can do to protect them.
There are planning options available to mitigate the impact, but much will depend on the type of funds, country of residence, what other investments you have, your risk tolerance, plus your family situation, objectives, time horizon and plans for the future. Professional, specialist advice is essential here, as you need to protect your retirement income as well as reduce tax for your heirs.
Be aware that pensions paperwork is complex and time-consuming. For example, obtaining a Non-Taxable (NT) code from HMRC and completing the necessary paperwork can take several months. While 2027 may seem some way off, in pension terms it’s not that far at all.
Delaying action could leave your family exposed to a significantly higher tax bill. Seek advice and start exploring solutions now.
Keep up to date on the financial issues that may affect you on the Blevins Franks news page at www.blevinsfranks.com