Pension Inheritance Tax Changes – What You Need to Know

The Autumn Budget 2024 delivered its fair share of surprises. But nearly a year on, there’s one significant change that still stands out. How pensions are treated after death.

Although changes won’t come into effect until April 2027, the proposed pension inheritance tax changes remain a key topic. If you’re someone who’s worked hard to build a pension pot, whether for comfortable retirement or to leave a legacy, it’s worth revisiting what these changes could mean for you.

Let’s break down the key details.

What Are the Current Rules for Your Pension?

Pensions have long been an efficient way to save for retirement. For a higher rate taxpayer, HMRC will add 66p for every £1 a member saves by way of income tax relief. Once invested, your funds grow free from tax. And, if you don’t need all your pension in retirement, any leftover funds can typically be passed on free from Inheritance Tax (IHT) on death.

It’s this last point that’s now under review.

What’s Changing?

The government’s new measure proposes bringing most pensions into the scope of inheritance tax from April 2027. Under the changes, pension scheme administrators will be responsible for reporting and paying any IHT due on death benefits and unused funds.

While the mechanics may sound administrative, the potential impact is far-reaching especially for anyone hoping to pass on their pension savings to loved ones.

What Does This Mean for You?

In simple terms: there will be a bit more complexity. These changes could make it much harder for families to strike a balance between maintaining a sustainable income through retirement and leaving a meaningful legacy for future generations.

Thresholds for inheritance tax have been frozen until 2030. There are two key allowances to be aware of: the nil rate band and residence nil rate band. For married couples, these bands combine, meaning a couple could leave up to £1m to beneficiaries without attracting IHT. The average house price in the South East is about £440,000, rising to £564,000 in London. Own a second home or a few Buy to Lets? You could quickly find yourself bumping up against the threshold.

The £2 Million Question

If your assets exceed £1 million, a pension pot of £500,000 could face a whopping £200,000 inheritance tax bill. Larger estates could be hit harder still.

That’s because once your estate surpasses £2 million, the Residence Nil Rate Band (RNRB) starts to taper away. Combining the loss of the RNRB with the impact of IHT on the pension pot and income tax at the beneficiaries’ marginal rate gives rise to an effective tax rate of over 80%.

Yes, you read that correctly. Out of every £100 in pension savings, your loved ones might only see £20 after tax.

Time to Act

April 2027 may sound a long way off, but when it comes to estate planning, the clock is already ticking. The complexity and potential cost of these pension inheritance tax changes mean early action is essential.

These proposed changes to pension IHT are more than a technical footnote in the Budget. They’re a seismic shift in how we think about retirement and legacy planning.

Careful, strategic planning could help you stay ahead. Whatever your situation, now is a good time to seek professional advice.

If you want to ensure your pension works for you and your family and not the taxman, reach out to your financial advisor or if you’d like to learn more, please get in touch on 020 7467 2700 or at hello@firstwealth.co.uk.

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