Pension ‘death tax’ changes loom

The countdown has begun to the introduction of new rules on how pensions are treated after someone dies.

In the “biggest shake-up of inheritance rules in a generation”, said The Telegraph, the value of a pension will, from April 2027, form part of someone’s estate after they die.

This could mean an inheritance tax bill for one in five households, said The Times, so “the countdown is on to protect their family wealth”.

What is the pensions death tax?

Putting money into a pension has traditionally been “one of the most tax-efficient ways to pass wealth on to loved ones”, said Rest Less. But any unused money in the pot from next year will fall into the scope of inheritance tax, “potentially reducing the amount families receive when someone dies”.

The proposals were announced in the October 2024 Budget by Chancellor Rachel Reeves. They aim to address concerns, said Dentons, that pensions were “increasingly being used as vehicles for inheritance planning, rather than for their primary purpose of providing retirement income”.

Who will be affected?

Inheritance tax is paid on the value of an estate above £325,000. Additionally, there is a £175,000 allowance for your main residence.

The tax “isn’t going to be an issue for most people”, said Royal London, but you may be affected if you own your own home and the value of your pension is added due to the potential total amounts.

The changes will still affect “most individuals” who have unused pension benefits when they die, said Tax Adviser. This means pensions can no longer be relied on as an “efficient means of passing” on wealth such as to your children. This could apply to millions who were previously free of it.

Inheritance tax receipts have already been rising due to “years of property price growth, asset inflation and frozen tax thresholds”, said The Times, so including pensions “will accelerate the trend”.

Beyond the potential charge, “of greatest concern”, said Wedlake Bell, is that payment of inheritance tax on pension assets will remain six months from the end of the month when the deceased died and interest on unpaid inheritance tax is currently running at 7.75%. The government has rejected calls to give bereaved families more time to pay.

Many families could face paying interest, said MoneyWeek, “due to administrative jams” involved in finding pension information and getting the right valuations.

How to prepare for the changes

If you are retired “it might make sense” to prioritise taking money from your pension before other assets, said Grovely Financial, especially if your goal is “inheritance tax mitigation”.

Another option, said MoneyWeek, is to “give away money while you are alive” so you can watch your loved ones enjoy it.

Up to £3,000 per tax year can be given as a financial gift, and tax-free gifts can be made to your children worth up to £5,000 for a wedding or civil partnership or £2,500 for a grandchild or great-grandchild.

Any money given outside of the gifting allowances is tax-free as long as you live for seven years after transfer. Gifting allowances can be used to pass cash on to loved ones, or alternatively, for extra net income.

Alternatively, there are life insurance policies that pay out to cover the cost of inheritance tax. They work in a similar way to other life insurance products: you pay premiums while you are alive “and there will be a payout when you die”, said The Independent.