One of the most significant announcements in Labour’s first Budget on October 31 was Chancellor Rachel Reeves’s announcement that pensions would become subject to inheritance tax. The move reverses George Osborne’s decision in 2015 to exempt pension pots from being considered part of an estate for inheritance tax purposes

What has changed?

Currently, private pensions are not considered part of your estate and are free from inheritance tax. If someone passes away before age 75, beneficiaries inherit the pension tax-free. If they die after age 75, only income tax applies to beneficiaries’ withdrawals, and inheritance tax remains excluded

However, that will all change from April 2027. From that date, unused defined contribution pension assets within the estate will be subject to inheritance tax at 40% for estates exceeding the nil-rate band of £325,000 (with an additional £175,000 allowance if the property is passed to direct descendants, subject to tapering not applying and the property being of sufficient value)

This policy shift, aimed at increasing tax revenue, is estimated to affect around 8% of estates and generate an additional £3.3 billion for the Treasury by 2030​

For many, this adjustment means that pension funds will no longer be an entirely tax-free way to pass on wealth. As the IHT threshold is frozen until 2030, more and more estates could exceed this limit, resulting in higher tax burdens for beneficiaries

What can you do about it?

For those who could afford it, the advice has always been to touch your pensions as the last source of income in retirement. Now, Reeves’ actions will, at the very least, necessitate a review of current plans

Advisers are warning that the change means families will have to rethink their inheritance planning

Before taking any precipitate actions, it is worth noting that:

• Pensions can still pass between spouses without IHT, meaning married couples and civil partners can continue joint planning strategies to minimise tax
• Gifts to a third party will still fall under the Potentially Exempt Transfer (PET) rules, which means that any gift is not subject to inheritance tax as long as the person making that gift does not die within seven years from the date the gift was made
• The rule change does not come into effect for almost three years, so there is little need for a knee-jerk reaction

Potential strategies

The above notwithstanding, and bearing in mind the seven-year rule on PETs, it may be appropriate to consider one or more of the following:

• Withdraw the tax-free element of the pension (up to 25%) and gift it in the hope of surviving seven years
• Begin to withdraw money from the pension as a first, rather than a last, resort, thereby reducing the value of the pension that is subject to IHT
• Within this, withdraw more than you require using drawdown and make regular gifts ‘from income’, thereby benefiting from what is known as the “normal expenditure from income exemption”. Under this exemption, you can give away unlimited amounts from income if you can show that such gifting is not affecting your usual standard of living. Note, however, that you have to pay income tax on withdrawals from a pension
• Take out an insurance policy to cover the increase in IHT resulting from pensions now being included in the estate

Whatever you’re considering, remember that it’s always important to seek professional advice before making any big decisions

Caveat emptor!