Families will face a “double tax” hit on unspent pension pots and a tight six-month deadline to pay Inheritance Tax (IHT) under new rules coming into force in April 2027, wealth managers have warned.
New Pension Rules: Double Tax and Six-Month Deadline
The Government has confirmed that unused pension funds will be brought within the scope of IHT for the first time. This change will combine with Income Tax on withdrawals to create a significant extra burden for some estates, adding layers of complexity to an already challenging system for grieving families.
Beneficiaries will have to decide whether to instruct pension providers to pay a proportional share of the overall IHT bill from the pension itself (if £1,000 or more) or cover the full liability from other assets. Providers must then pay HMRC within 35 days of notification. However, this choice can leave some family members worse off, depending on their tax positions.
Henrietta Grimston, Chartered Financial Planner at Saltus, said: “When deciding how best to divide up responsibility for the IHT bill, personal representatives must ensure they do not inadvertently put one or more beneficiaries at a disadvantage.”
“In some cases, beneficiaries may be better off instructing the pension provider to pay a portion of the IHT due on the unspent pension.”
For those who die after age 75, lump sums or withdrawals taken by beneficiaries will be taxed at their marginal rate of Income Tax – up to 45% for additional rate taxpayers. Instructing the pension provider to cover part of the IHT can therefore reduce the overall tax bill in some circumstances.
Estates will have just six months from the date of death to settle the full IHT liability on the total estate, after which interest will start to accrue. The deadline creates particular problems for families dealing with multiple pension pots from different providers or illiquid assets such as property held within pensions, which can be hard to value or sell quickly.
Ms Grimston added: “Administratively, these new rules are hard to meet. Managing multiple pension providers at once, getting the valuation of the unspent pension and working out the proportional share on each of those pensions is a time-consuming process.”
“The danger here is that, keen to avoid late payment fees, many beneficiaries will rush the early stages of the process and ask the pension provider to settle a share of the IHT owed. While this may seem to be a sensible approach at first, it can ultimately leave some beneficiaries worse off in the long run.”
The changes, first announced in the Autumn Budget, have already prompted many high net worth individuals to review their estate planning. According to the latest Saltus Wealth Index, a survey of 2,000 UK adults with £250,000 or more in investable assets (excluding primary residence), 21% are concerned about the impact on passing on pension benefits, while 26% are actively considering strategies to protect their pensions from IHT.
Common tactics include drawing tax-free cash in smaller tranches, making gifts out of excess income, placing life insurance in trust, or leaving money to charity. Ms Grimston said: “While some question marks remain around how this new regime works, the Government’s latest guidance has provided some transparency.”
“While there is no one-size-fits-all solution, anyone thinking of taking immediate action to reduce their liability must know what their tax rate is to withdraw from the pension, what their children’s or beneficiaries’ tax rates are, and what other assets they have. Only then will they be able to take an informed, holistic view of their finances and understand the most tax-efficient route forward.”
The new rules mark a major shift in the longstanding tax-efficient treatment of pensions as a vehicle for wealth transfer.
