How the taxation of defined contribution pensions will change from 2027 – and what you should do now
Did you think you were keeping down your Inheritance Tax bill by investing in your pension? Not so from 2027.
What’s changing?
Historically, investing in pensions has been a sensible choice…. your contributions attracted tax relief, your employer would top these up, then your savings would stay outside of your estate for inheritance tax (IHT) when you died. However, the Chancellor’s 2024 Budget changed that.
From 6 April 2027, defined contribution pensions will be counted as part of your estate for IHT, and potentially taxed at a rate of 40%.
What does this mean for me?
A lot of us will have used up all our pension savings when by the time we die, be that taking long-awaited holidays, or more commonly, paying care home fees. Since IHT broadly only starts to bite when estates contain assets totalling over £325,000, for many people, including pensions will have no impact. And anything that remains in the pot can be passed to a husband, wife or civil partner without being taxed.
But property prices in Buckinghamshire and Oxfordshire, and in the South East of England generally, have sky-rocketed in recent years. This means that although the personal representatives administering your estate when you die will be able to sell your Oxford or Marlow home for more than the UK average, your pension savings in conjunction with the property value may tip your estate into the remit of IHT.
If you manage to keep your assets away from IHT by passing your estate tax free to your surviving husband, wife or civil partner when you die, you may instead be storing up a future tax bill for their estate.
The Government estimates that the pensions changes will bring 10,500 estates into the charge to IHT for the first time, and that 38,500 will pay more IHT.
Bear in mind that any tax payable on your death means that there is less available in the pot for your loved ones.
Are death in service benefits taxable?
No, these remain exempt from IHT and are not part of your estate at death. However, pension benefits paid out should you die before your minimum pensionable age will be included in your estate.
If you die before you reach 75, your pension will still be available to those you leave behind, in the form of a tax-free income.
So what should I do now?
The Government is still working out the finer details on the law changes, but it’s safe to say that if you are likely to be hitting the IHT allowance thresholds, you may wish to reconsider where your savings are held.
Make sure you review your pension nomination form so that the fund trustees pass your savings to your husband, wife or civil partner if possible, to ensure that your pension benefits from the spouse exemption.
You may wish to consider drawing from your pension savings to make gifts to reduce the taxable value of your estate. If you survive 7 years from the date of the gift, you will have reduced your estate by the full amount of the gift. If you die within the 7 year period, the value of the gift will be added into your estate at death, although it will be reduced, depending on when the gift was made.
You could also consider leaving sums to charity in your Will. There are multiple benefits to making charitable legacies, reducing your estate chargeable to IHT being just one.
Finally, you will need to consider whether your estate is likely to hold sufficient, accessible cash on your death to enable your personal representatives to pay the IHT bill.
If you would like to discuss your estate and how you might be able to reduce the tax bill that your personal representatives face on your death, please contact Bethan Chant at bethan.chant@theburnsidepartnership.com.