Your pension could soon cost your family more in inheritance tax (IHT) than you think.
From April 2027, pension funds are set to form part of your taxable estate. However, for many families, the biggest surprise may not be the direct tax on the pension itself; the more significant issue could be the loss of the valuable Residence Nil Rate Band (RNRB).
Summary:
- Many pensions subject to IHT from April 2027
- Families with estates around £2m could lose Residence Nil Rate Band
- IHT bills may be bigger than feared
- If this sounds like you, consider reviewing your plans
Inheritance tax on pensions
The RNRB currently provides an additional inheritance tax allowance of £175,000 per person when a main residence is passed to direct descendants. Combined with the standard nil rate band, a married couple can potentially pass on up to £1 million before inheritance tax bites. However, there is an important catch. The RNRB is gradually withdrawn once an estate exceeds £2 million, reducing by £1 for every £2 above that threshold.
Until now, many individuals with substantial pension funds have remained below the £2 million threshold because their pension benefits sat outside their taxable estate. From April 2027, those same pension funds may be included when calculating the estate value. A family with a £1 million home, a £500,000 investment portfolio and £800,000 in pensions could suddenly find their estate valued at £2.3 million for inheritance tax purposes. Not only could the pension itself suffer inheritance tax, but the family could also lose some or all of their RNRB.
The impact can be severe. Every £1 of RNRB lost effectively increases the inheritance tax bill by 40p. This creates an effective inheritance tax rate of up to 60% on assets within the taper zone between £2 million and the point at which the allowance is fully lost. For some families, crossing the £2 million threshold because of pension wealth could add tens or even hundreds of thousands of pounds to the eventual tax bill.
In the example above, the tax bill could almost treble from £200,000 to £580,000
As a result, retirement and estate planning strategies may need to change. Pensions can no longer automatically be viewed as the “last asset to spend”. Instead, individuals should consider their total estate value, including pension funds, and assess whether drawing pension benefits during their lifetime, gifting out of your pension income, or restructuring assets could preserve valuable inheritance tax allowances and help their families.
Plan your pension with confidence with Mercer & Hole
If you have a pension, it now needs a plan. Our experts offer inheritance tax advice and pensions guidance to help you navigate your financial future.
Please get in touch with our Financial Planning team if you wish to discuss any of the matters mentioned above.
Disclaimer
Any investment will only be undertaken following an assessment of individual circumstances. Investments also carry risk and can increase and decrease in value and you may not get back the full amount invested.
Mercer & Hole Financial Planning is the trading name of M&H Financial Planning Ltd which is authorised and regulated by the Financial Conduct Authority – Number 710745.
