Reviewing the inheritance benefits of a pension: What you need to know after the 2024 Autumn Budget

Before the Autumn Budget 2024, pensions were widely regarded as one of the most tax-efficient vehicles for intergenerational wealth transfer. If a pension holder died before the age of 75, their beneficiaries could usually inherit the pension pot tax-free. If death occurred after 75, the funds could be passed on with only income tax applied when the beneficiary accessed the money. However, this income tax liability—often overlooked—could be substantial if large withdrawals were made in a single tax year, potentially reaching the 45% additional rate. Crucially, the pension pot was not considered part of the deceased’s estate for IHT purposes, making it an attractive option for estate planning.

This made pensions an attractive option for those looking to preserve wealth across generations, especially when compared to other assets deemed to be held within an estate like property or investments, which are typically subject to IHT at 40% above the nil-rate band and residence nil rate band, if eligible.

In a move that surprised many, the Chancellor announced that from 6 April 2027, unused pension funds and death benefits will be included in the value of a person’s estate for IHT purposes. This change applies regardless of whether the pension holder dies before or after the age of 75.

Under the new rules, if the total value of the estate—including the pension pot—exceeds the IHT thresholds (currently £325,000 for individuals and up to £175,000 for an individual’s residential home, subject to eligibility, so up to a possible £1,000,000 for couples), the excess may be taxed at 40%. This marks a significant departure from the previous regime and could have major implications for estate planning.

The changes will primarily affect individuals with substantial pension savings who had planned to use some or all of their pension as a vehicle for passing on wealth. While the majority of estates may still fall below the IHT thresholds, those with larger pension pots—particularly those who have not used their pensions—could see a significant portion of their unused pension subject to tax upon death.

Importantly, certain exemptions will still apply. For example, pension death benefits--such as lump sum payments from defined contribution pensions--paid to a spouse or civil partner will continue to benefit from inter-spousal IHT exemption, just like other assets passed between spouses. However, when the surviving spouse or partner passes away, any unused pension assets will be included in their estate, potentially pushing the total value above the IHT threshold.  

This could also result in the loss of the Residence Nil Rate Band (RNRB), which is tapered away for estates exceeding £2 million, thereby increasing the overall IHT liability. Additionally, for deaths occurring after age 75, beneficiaries may face double taxation—first through IHT on the value of the pension pot, and then income tax when they withdraw the funds—significantly reducing the amount ultimately received.

While the changes are not set to take effect until 2027, now may be a good time to review your estate planning strategy. Here are a few steps to consider:

1. Review your pension nominations: Ensure your beneficiary nominations are up to date and reflect your current wishes. This can help streamline the process and potentially reduce tax liabilities. You can contact your pension provider to review your Expression of Wish/Nomination form or complete one if you haven’t already done so.
2. Update your will: A valid and up-to-date will ensures that your assets, including pension death benefits where applicable, are distributed according to your wishes. It also helps avoid disputes and delays during probate. Many people overlook this step, but it’s essential for effective estate planning.
3. Consider life insurance to cover potential IHT liabilities: If your estate is likely to exceed the IHT threshold, a life insurance policy written in trust can help cover the tax bill, ensuring your beneficiaries receive the full value of your estate without needing to sell assets to pay the tax.
4. Spend your pension: Drawing down your pension during your lifetime may reduce the value of your estate and therefore the potential IHT liability. However, this must be balanced against your own retirement income needs and that of your spouse or civil partner if they rely on you should you pass away before them.
5. Explore trusts and gifting: Other estate planning tools, such as trusts or lifetime gifting, may become more attractive under the new rules. Professional advice is essential to navigate these options effectively.
6. Speak to a financial adviser: Given the complexity of the new rules and the potential tax implications, consulting with a financial adviser is highly recommended.

The inheritance benefits of pensions have long made them a powerful tool for wealth preservation. However, the changes announced in the Autumn Budget 2024 represent a significant shift in the landscape. From April 2027, unused pension funds will be brought within the scope of inheritance tax, potentially reducing the amount that beneficiaries receive.

While these changes may seem daunting, they also present an opportunity to reassess and refine your financial plans. With careful planning and professional advice, it is still possible to make the most of your pension savings—both for your retirement and for the legacy you leave behind.

This article is for information purposes only. It is not intended as advice.

Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits which isn't guaranteed and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.

Schroders Personal Wealth does not provide estate planning and administration, trust management or will writing, however we can introduce you to a relevant specialist. We might receive a referral fee from some of the partners we introduce to you.