By Kevin Wood, CFP™ - May 2025

In the Autumn Budget of October 2024, Chancellor Rachel Reeves announced significant changes to how pensions will be treated for inheritance tax (IHT) purposes. From April 2027, pension pots will no longer remain outside of your estate for IHT calculations – a change that could have far-reaching consequences for many families across the UK. This shift, combined with frozen IHT thresholds until 2030, means many individuals who wouldn't currently face an inheritance tax bill could find themselves drawn into the net, while others may see their liability increase dramatically.

The Growing IHT Burden on Ordinary Families

The traditional view that inheritance tax is only a concern for the very wealthy is rapidly becoming outdated. Recent analysis reveals how the combination of asset growth, frozen thresholds, and soon-to-be-included pension assets could create significant tax burdens for ordinary families who previously would have had little or no IHT liability.

Currently, a married couple can typically pass on up to £1 million tax-free when considering their combined nil-rate bands and residence nil-rate bands. However, once pensions are included in estate calculations after April 2027, the picture changes dramatically.

Understanding the Scale of Impact

Recent research from wealth managers shows just how substantial this change could be. For example, a couple in their 30s with modest assets and average pension contributions who would currently face no IHT liability could see their estate incur a tax bill of over £180,000 by 2030. Middle-aged couples in their 50s with larger pension pots might see potential IHT liabilities rise from a manageable £20,000 to over £800,000 in just five years. Retired individuals over 75 face a potential "double whammy" where their pension could be subject to both IHT (at 40%) and income tax (at the beneficiary's marginal rate) – potentially resulting in effective tax rates of up to 67%.

The changes will particularly impact those who have been following conventional financial wisdom by preserving their pension assets and using other sources of wealth first – a strategy that has, until now, been tax-efficient.

How the New Rules Will Work

From April 2027, most unused pension funds and death benefits will be included within a person's estate for inheritance tax calculations. The standard IHT threshold of £325,000 per person remains unchanged, alongside the residence nil-rate band of £175,000 when passing a home to direct descendants.

Importantly, pension death benefits paid to a spouse or civil partner will remain exempt from IHT, provided they are UK domiciled. However, beneficiaries could now face both income tax and inheritance tax on inherited pensions, with combined rates potentially reaching 67% in some scenarios.

Planning Ahead: Strategies to Consider

With nearly two years until implementation, there is time to review your financial and estate planning. Here are some strategies worth considering:

Revisit Your Retirement Decumulation Strategy

The order in which you use various assets during retirement may need reconsideration. Rather than preserving pension wealth at all costs, a more balanced approach may be appropriate, using pension assets strategically alongside other savings and investments.

Consider Lifetime Gifting

The seven-year rule for gifts remains unchanged, meaning assets given away more than seven years before death typically fall outside your estate for IHT purposes. Regular gifts made from surplus income can also be immediately exempt from IHT if they meet certain criteria.

Review Your Will and Beneficiary Nominations

Ensure your will and pension beneficiary nominations are structured optimally. In some cases, directing pension benefits to specific individuals or trusts may help manage the IHT impact.

Explore Alternative Tax-Efficient Investments

Certain investments, such as those qualifying for Business Relief, can be exempt from IHT after just two years. These might form part of a diversified approach for some investors, though they typically carry higher risks.

Consider Life Insurance in Trust

Life insurance policies written in trust appear to remain outside the scope of IHT under the new rules. A suitable policy could provide funds to help beneficiaries meet any IHT liability without further depleting the estate.

Time to Act – But Don't Rush

These changes represent a significant shift in retirement and estate planning. While there's no need for hasty decisions, it's worth beginning conversations now about how these changes might affect your long-term financial plans.

The key is to balance competing priorities – ensuring you have sufficient funds for your own retirement needs while managing potential tax liabilities for your beneficiaries. Every family's circumstances are different, and the optimal approach will depend on your overall financial situation, objectives, and family circumstances.

At Oak Four, we believe in taking a holistic approach to financial life planning that considers these changes within the context of your broader goals and values. If you'd like to discuss how these upcoming pension changes might affect your estate planning and what strategies might be appropriate for you, please do get in touch for a conversation.

Remember, while tax efficiency is important, it should never be the sole driver of your financial decisions. The most effective planning aligns tax considerations with your broader life goals and what matters most to you and your family.