The move to bring most unused pension funds and death benefits within the value of a person’s estate for inheritance tax (IHT) purposes from 6 April 2027 was the biggest pension change in last month’s Budget.
And while the implementation is more than two years away, it is already the subject of many questions from advisers and clients.
Much of the focus has, understandably, been on the impact on pension savings and the potential change to the order in which people take retirement income from different wrappers in future.
But it’s also worth considering the wider impact this change may have on general IHT planning.
The new rules could have a significant impact on the finances of those who have saved hard during their lifetimes
A number of clients may have established a position where at least 10% of the net estate is left to charity. If this is set up correctly, then a reduced IHT rate of 36% will apply.
In order to claim the 36% rate of IHT, the amount going to charity must equal at least 10% of the overall chargeable estate, which is the value after the nil-rate band (NRB) and any other reliefs and exemptions have been applied.
After April 2027, if a significant pension asset falls into the estate, that could fundamentally alter the calculations involved and mean any existing arrangements may not be sufficient to qualify for the lower IHT rate.
Another area that may be affected is the availability of the residential nil-rate band (RNRB).
Passing pension funds to a spouse or civil partner may give more opportunities to remove the funds from the estate before second death
The RNRB is £175,000 and will be frozen at that level until at least April 2030 (along with the £325,000 NRB). It’s available to those passing on a qualifying residence on death to their direct descendants. However, a taper reduces the amount of the RNRB by £1 for every £2 the net estate is more than £2m. That means estates of £2.35m or greater don’t benefit from the RNRB.
Currently, a client may have an estate valued below the £2m figure, so the RNRB is available in full. But, if, after April 2027, a pension is added into the estate, that may take some above the £2m level and see the RNRB reduced.
Small self-administered schemes (SSAS) are another area that could be affected by these changes. Often these schemes hold a commercial property used by the sponsoring employer.
Following death of one of the members, often schemes are set up so the value of that property is cascaded to beneficiaries who are already members of the SSAS. That can help preserve a key asset, removing any need to sell the property.
If, after April 2027, a pension is added into the estate, that may take some above the £2m level and see the RNRB reduced
However, if, after 2027, an IHT charge is due, that may impact that set up and mean there aren’t enough liquid assets to pay the IHT bill from the pension, potentially forcing a property sale. Sipps holding commercial property may likewise have some increased liquidity issues following death.
The inclusion of pensions within IHT will mean more people will be subject to the tax, and it could have a significant impact on the finances of those who have saved hard during their lifetimes.
Wills and savings plans may need to be reorganised. Planned sources of retirement income may need to be altered. Those who were using the pension purely as a vehicle to pass funds to the next generation may need to re-consider some aspects. For example, taking tax-free cash around age 75, which means (at worst) that amount is only subject to IHT, rather than IHT and income tax.
It is already the subject of many questions from advisers and clients
And passing pension funds to a spouse or civil partner may give more opportunities to remove the funds from the estate before second death.
But this change isn’t happening until 2027, so there is a long time for details to emerge about how this will work in practice. While its understandable many people have questions and a desire to take action, there isn’t an immediate need to make plans now. But it is an area to keep a close eye on.
Andrew Tully is technical services director at Nucleus
This measure is, compared to the other IHT madness, quite reasonable and predictable.
Those with the biggest non vested sums have probably received the most tax relief, and at higher releif levels. Planning is/was aided certainly as annuity purchase can be postponed to an older age, yet, I doubt if Parliament ever saw this benefit as a planned goody under the legislation.
With the removal, or non reinstatement, of the fund value cap, some form of claw back was inevitable.
These changes disproportionately impact upon single people. Never in history has there been more of an incentive to die or get married. How depressing!