Significant Tax Change for Pensions from 2027
In a substantial shift in estate planning policy, the recent Autumn Budget announcement revealed that from April 2027, inheritance tax (IHT) will be applied to pension assets. Chancellor Rachel Reeves stated this change will impact approximately 8% of estates annually, altering how pensions can be used in financial plans. For advisers, this calls for a strategic pivot: pensions will likely serve primarily as retirement income vehicles rather than inheritance tools.
Understanding the New IHT Policy on Pensions
The Treasury has released a consultation document outlining how this policy will be implemented. One key point is that dependents’ pensions will remain outside the scope of this tax. A spouse or civil partner can still receive pension benefits tax-free, while pensions passed to other beneficiaries may face both income tax at the recipient’s marginal rate and the new IHT levy, effectively subjecting these assets to double taxation.
For some pensions, the changes could lead to extreme tax rates, potentially reaching 90%. As an example provided by RSM, an accountancy firm, if an estate is above £2 million, losing the residence nil rate band could mean a Scottish beneficiary might only see £29,906 from a £350,000 pension pot, after an effective tax rate of over 90%.
New Challenges for Bereaved Families and Administrators
Applying IHT to pensions could create additional complexities in the probate process. Steve Webb, a former pensions minister, warns that these changes may delay access to pension assets for bereaved families. Identifying and notifying all pension schemes of a death will be required, and families must compile necessary details before using an HMRC calculator to determine the IHT amount due.
With pensions now part of the taxable estate, beneficiaries may need to navigate a more complex, time-consuming process. Even lump sums, such as death-in-service benefits, could face tax rates of up to 40%, further complicating inheritance timelines and reducing expected payouts.
Market Implications and Strategic Shifts for Advisers
With marriage offering tax protection, the new rules may most affect single or cohabiting individuals who lack the spousal exemption. Life insurance policies might see a resurgence in popularity as an alternative estate planning tool, according to Clare Moffat, head of technical at Royal London. Advisers may also consider strategies like using surplus income to fund younger family members’ pensions or ISAs as part of a long-term planning approach.
Tom McPhail, director of policy at The Lang Cat consultancy, highlighted that from 2027, savers will likely reconsider how they manage their retirement funds, with less incentive to build larger pension pots. For higher earners, this change could prompt earlier withdrawals from pension accounts and increased demand for annuities. Additionally, pension providers who rely on assets under management may feel the effects as savers withdraw pension funds sooner to avoid punitive taxes.
Practical Impacts on Financial Advisers and Client Planning
Financial advisers have long anticipated that pension taxation would eventually be reformed, and many see the new rules as aligning pensions more closely with other types of assets in estate planning. Jo French, CEO of Attivo, believes that the generous tax treatment of pensions in inheritance planning was never intended to be permanent.
As she put it, “Pensions offer great tax benefits, but they aren’t meant as inheritance vehicles. Advisers now have an opportunity to help clients consider a broader array of estate planning strategies.” Greg Moss, director at Eleven.2 Financial Planning, agrees, observing that the changes bring pensions more in line with non-pension investments, which may simplify client understanding of inheritance planning.
Preparing for the Shift
The upcoming changes present advisers with a chance to guide clients through new, tax-efficient ways to pass on wealth. With pensions now less attractive for inheritance purposes, advisers can discuss life insurance and other legacy strategies with clients to meet their estate planning goals while considering the impact of the new tax rules.
While the changes are complex, they are also an opportunity for advisers to reinforce the role of pensions as a secure income source for retirement. Early planning and informed advice will be essential in adapting to this evolving tax landscape, ensuring that clients’ financial and inheritance goals are aligned under the new regulations.