Individuals with significant pension savings could face combined inheritance and income tax exposure of up to 67% once pensions are brought within the scope of inheritance tax warns Claritas Tax.
From 6 April 2027, most unused pension funds and death benefits will be included within an individual’s estate for inheritance tax purposes and it is estimated that approximately 38,500 estates will pay more inheritance tax, with the average liability among affected estates increasing by around £34,000[1].
Adam Keates, Associate Partner at Claritas Tax, comments:
“There is no silver bullet for wealthy individuals with well-funded pensions. Reducing the future inheritance tax exposure may mean drawing money from a pension and triggering income tax during their lifetime.
“That could still be attractive compared with a potential combined tax exposure of up to 67% at death[2]. However, individuals should not simply empty their pensions and conversations with financial advisers, as well as tax advisers, are strongly recommended. Any decision must consider the immediate income tax cost, future retirement needs and what happens to the funds once they have been withdrawn.”
Planning options may include using pension withdrawals to make regular gifts from surplus income, which can be immediately exempt from inheritance tax if certain conditions are met. Larger one-off gifts may also fall outside the estate if the individual survives for seven years from the date of the gift and retains no entitlement to benefit from the funds gifted.[3]
Other options could include reinvesting pension income in tax advantaged EIS or SEIS investments, although these carry significant commercial risk and should not be considered without regulated investment advice. Retiring overseas may also affect the tax treatment of pension income, depending on the relevant double taxation agreement and the individual’s circumstances.
“The long-established approach of preserving a pension and spending other assets first may no longer be appropriate for everyone. “Those with significant pension wealth should review their retirement and estate-planning strategy before April 2027. Tax should not be the sole driving factor of any financial decision-making; the aim should not be to withdraw money solely to avoid inheritance tax, but to determine whether paying some income tax during their lifetime could produce a better overall outcome for them and their family as part of a wider strategy for succession and financial security,” concludes Adam Keates.
[1] https://www.gov.uk/government/publications/inheritance-tax-unused-pension-funds-and-death-benefits/inheritance-tax-unused-pension-funds-and-death-benefits
[2] This assumes IHT at 40% on the value of the pension fund, and then 45% income tax on the balance
[3] https://www.gov.uk/inheritance-tax/gifts
