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In the Autumn Budget, the Chancellor said that inheritance tax thresholds, which are the amount you can pass on when you die, before inheritance tax is due, are staying the same until 2030. But, from April 2027, pensions will no longer be exempt from inheritance tax. That means that inheritance tax may have to be paid on your pension when you die.
It’s important to note that we don’t yet have the finalised legislation, so things could change. We are also still waiting on more detail.
How inheritance tax on pensions currently works
Currently, defined contribution pensions, where you build up a pot of money to give you an income when you retire, wouldn’t normally be part of your estate and there would be no inheritance tax to pay. The ‘estate’ simply means all the assets, like a house, investments or valuables, that someone owns when they die. But from 6 April 2027 defined contribution pensions will be subject to inheritance tax. The standard rate of inheritance tax is 40%.
Who will be affected by the change to inheritance tax?
Even with this change, inheritance tax isn’t going to be an issue for most people. That’s because everyone has an entitlement to a nil rate band of £325,000 of assets which they can leave to anyone free of inheritance tax. This is also known as the inheritance tax threshold.
We know that many people don’t have enough in their pension for the lifestyle they’d like in retirement, so they may not have much, if any, money left in their pension(s) when they die. Often pensions are passed onto the pension saver’s husband or wife and if they don’t have their own pension, or only have a small pension, then they will need that pension to top up any pension savings they have. Government figures estimate that 10,500 estates will pay inheritance tax for the first time, as a result of the changes to the rules on inheritance tax and pensions, and 38,500 will pay more inheritance tax.
But if you own your own home, then when your defined contribution pension is added onto this, it might be more than the amount you’re able to pass on free of inheritance tax. And that could mean inheritance tax has to be paid when you die or when your husband or wife dies.
If you are married or have a civil partner
If a couple are married and live in the UK, then when the first member of the couple dies, and anything they own is passed onto their husband, wife or civil partner then there is no inheritance tax to pay. This means that some or all of the £325,000 inheritance tax nil rate band which was unused on the death of the first person can be transferred to the surviving husband, wife or partner. So, this means that up to £650,000 (2 x £325,000) is available when the surviving husband or wife dies, before inheritance tax is paid.
In addition, if you pass on a property or the proceeds of a property sale to children, then you are also entitled to something called the residence nil rate band. That’s up to an extra £175,000 that each member of a couple can pass on free of inheritance tax. However, the residence nil rate band only applies if direct descendants benefit. That means children, including stepchildren, and grandchildren. If you are married or in a civil partnership, then this, like the inheritance tax nil rate band, can also be transferred if the first person hasn’t used it. So, on the death of the surviving husband, wife or civil partner, there is a maximum of £1 million pounds available inheritance tax free, which is 2 x £325,000 (the nil rate band) and 2 x £175,000 (the residence nil rate band).
If you live together but aren’t married
If a couple live together but aren’t married – the same rules don’t apply as the nil rate band and the residence nil rate band can’t be transferred to the surviving partner if they aren’t used. Couples who live together also can’t pass on assets to each other free of inheritance tax when they die.
So, when the first partner in a couple dies there is only £325,000 available before inheritance tax is due rather than an unlimited amount. That means if one partner dies first and leaves £1 million to the person they live with, there will be inheritance tax to pay on anything over £325,000.
An example of the change in relation to pensions and inheritance tax
The best way to explain the inheritance tax changes is with an example. We will look at Khalid and Amira, who are married. Sadly, Khalid dies in 2024, and he leaves everything to his wife Amira. Then Amira dies in May 2027. We are assuming that the law on inheritance tax and pensions will have changed to take effect from 6 April 2027.
We will also assume that Amira owns a house worth £400,000, that she has £100,000 of investments in ISAs, has her own pension worth £200,000 and that she inherited a pension from Khalid in 2024 which is now worth £650,000. Before April 2027, when pensions weren’t generally subject to inheritance tax, there would have been no inheritance tax bill because the estate was worth £500,000. That means it would have been under the £1 million limit that could have been passed onto someone other than a husband, wife or civil partner, with no inheritance tax to pay.
However, with the change meaning that pensions are subject to inheritance tax from April 2027, the total estate would now include pensions and would be worth £1,350,000. This means that £350,000 would be subject to inheritance tax at 40% which will be £140,000.
Do I need to include my pension in my will?
There should be no need to add your pension to your will because of the change to inheritance tax and pensions announced in the Autumn Budget 2024. Although there is no finalised legislation yet, our understanding is that there won’t need to be any change to what you have set up currently and you won’t need to add your pensions to your will. The pension company and the solicitor for the estate will work together to sort out any inheritance tax that’s due.
How to reduce the effect of the changes to inheritance tax
If you have a lot of money in pensions as well as other assets then it might be a good idea to talk to a financial adviser to work out the most tax-efficient way to spend money in retirement. If you are 75 or over when you die, those who inherit your defined contribution pensions will have to pay income tax. You can read our article which gives more information on that tax charge.
Giving away money while you are still alive
This isn’t something new, but it might be useful if your estate (the value of your property, investments and other assets, including your defined contribution pension or pensions) will just be over the inheritance tax threshold. You might want to think about giving away more money when you are alive, especially if you’ve received the pension from your husband or wife and will be passing on your estate to children or other family or friends.
That could be giving lump sums or paying into pensions or ISAs for adult children or younger children or grandchildren to help with their retirement or perhaps to help get them onto the property ladder. Anyone can have a pension, even those under 18. However, it is important to say that giving money away may not be the right thing to do. You should ensure you have enough to give you the lifestyle you want in retirement. As we mentioned earlier, it’s a good idea to take advice from an impartial financial adviser.
