Unpacking the Budget Part 4: Key change to inheritance tax treatment of inherited pension funds and planning tips

As the 2024 Autumn Budget approached, discussion grew about possible changes to pensions, including limits on pension commencement lump sums (PCLS) and adjustments to tax relief on contributions.

In a surprising twist, it was announced that most pension death benefits will be brought into the inheritance tax (IHT) regime with effect from 6 April 2027. The Government has opened a consultation on implementing the changes, which ends on 22 January 2025, but the fundamentals are expected to remain as announced.

In part 4 of our ‘Unpacking the Budget’ series, we break down the changes, highlight what remains the same and offer practical planning tips to help you stay prepared.

What hasn’t changed?

Despite some dramatic announcements, key aspects of pension tax relief remain untouched:

• No changes to tax relief on contributions
• No changes to pension Annual Allowance and carry forward provisions
• No national insurance changes on employer pension contributions
• No reintroduction of Lifetime Allowance – this was replaced by the Lump Sum and Death Benefit Allowance (LSDBA), which remains at £1,073,100
• PCLS remains at £268,275 – this allowance is known as the Lump Sum Allowance (LSA)

What has changed?

From 6 April 2027, subject to confirmation, unused pension funds will be brought within the scope of inheritance tax. Other than for transfers of unused pension funds between spouses and civil partners, which will remain exempt. This means that inherited pensions will be subject to 40% inheritance tax. Additionally, for beneficiaries of pension members who pass away after reaching age 75, the inherited pensions will also be subject to income tax at the beneficiary’s marginal rate. In some cases, the combined effective rate of tax could be as high as 67% without careful planning.

In fact, the pension fund tax liability could impact on a claim for residence nil rate band, which is tapered for estates above £2 million, and could increase the effective tax rate to more than 90% in the worst cases.

George Osborne introduced the concept of being able to smoothly cascade unused pension funds down the generations in his ‘pension freedoms’ reforms introduced in 2015. For high-net-worth clients, those changes somewhat inadvertently led to pension funds being funded primarily for estate planning purposes rather than the intended retirement funding. It became standard practice to use other assets for retirement planning ahead of accessing pension benefits where possible.

What should I do?

To navigate these upcoming changes effectively, we recommend considering the following steps:

• Review existing plans and strategies to ensure they remain fit for purpose. April 2027 is still some time away which enables careful thought to be applied to best laid plans.
• Review death benefit nominations to ensure they reflect current wishes and optimise tax efficiency.
• Consider drawing PCLS sooner, as these funds could be better deployed or even gifted to fall outside of the estate after 7 years.
• Consolidating pension assets could alleviate some of the admin burden. Under the draft plans, personal representatives will be required to calculate the tax liability due on the pension scheme assets and liaise with the pension scheme administrators to make payment. For individuals with multiple pension pots, this could be quite onerous. Consolidating pension assets could alleviate some of the administrative burden while potentially improving outcomes for the member.
• Bring forward the sale of your property especially if it is held in your pension, as lack of liquidity may cause issues down the line (as the IHT bill would need to be paid within a certain time). In such cases, it may make sense to bring forward the sale of such an asset if appropriate.
• Revisiting IHT planning strategies is paramount. The thought of losing 40% of a pension fund could have a significant impact on the ultimate beneficiaries. With this in mind, we strongly recommend that inheritance tax planning strategies should be reassessed.

How can we help

Lubbock Fine and Lubbock Fine Wealth Management are well placed to offer advice and guidance in key areas of estate planning in advance of the announced changes. With the proposed changes set to impact a significant number of individuals, proactive planning now can save time, stress, and money in the long term.

If you would like to discuss how these changes affect you or explore planning strategies, please get in touch with our LFWM Director, Andrew Tricker (andrewtricker@lfwm.co.uk).

*A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). 
The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available.  
Your pension income could also be affected by the interest rates at the time you take your benefits.

This blog post has been written by Lubbock Fine Wealth Management (LFWM). The opinions and views expressed are those of LFWM and do not necessarily reflect 
those of Lubbock Fine. All information provided in this blog is for informational purposes only and should not be considered professional advice. 
The Financial Conduct Authority does not regulate Tax Planning or Estate Planning. LFWM is not responsible for any actions taken based on the content of this blog.