Key takeaways
From April 2027 undrawn pensions will be subject to Inheritance Tax
This will be taxed at the current Inheritance Tax rate of 40%.
There are opportunities to plan to mitigate the Inheritance Tax
Drawing income from pensions now could be gifted Inheritance Tax free.
Business owners need to consider existing SSAS arrangements
Reviewing existing arrangements where a SSAS holds the company’s premises is key.
Proposed changes to the Inheritance Tax treatment of pensions on death is due to take effect in April 2027. The long-held principles for pension planning and post death pension administration are now facing huge changes which will have far reaching implications for both members of pension schemes and those administering them.
Which pensions will be subject to Inheritance Tax?
Most unused pension funds will be impacted by the new rules, including personal pensions, SIPPs and SSASs. The value held within such pensions on death will, from April 2027, be subject to Inheritance Tax at the current rate of 40%.
The unused pension fund will have the benefit of a portion of the deceased’s available Inheritance Tax free allowance (known as the nil rate band which is currently £325,000). Additionally, where the pension passes to the deceased’s spouse, it will benefit from the spouse exemption, so no Inheritance Tax is payable on the value of any pension passing to a spouse.
However, the pension fund will also form part of the deceased’s estate for assessing the availability of the residence nil rate band (an additional Inheritance Tax free allowance of up to £175,000 per person if the deceased’s main residence passes to their lineal descendants). This could therefore push the value of some estates over £2 million resulting in a partial or total loss of the residence nil rate band and bringing more of the deceased’s estate into the 40% Inheritance Tax charge.
The double tax trap
While the rules change the treatment of pensions for Inheritance Tax purposes, the rules for income tax on pensions look to remain unchanged.
This therefore means that for unused pensions where the deceased was over the age of 75, Inheritance Tax will be payable on the value of the pension at the current 40% rate and income tax will then be payable on the balance at the marginal rate of the beneficiaries when they access the funds.
Succession planning for pensions
The proposed changes are already making people think about how they use their pensions. This includes decisions about whether to still contribute to a pension, whether tax free lump sum benefits should be taken sooner rather than later or whether to draw more income from the pension during lifetime.
Careful consideration is needed in relation to every aspect of lifetime pension planning. This is essential to fully understand the Inheritance Tax and income tax implications, as well as the practical financial planning aspects of effectively using available resources during retirement.
In some circumstances, it may be prudent to draw income from existing pensions and make gifts of this during lifetime. If done correctly, this could be Inheritance Tax free, benefitting from exemptions to the usual gifting rules that apply for Inheritance Tax purposes.
For others, the higher rates of income tax payable when drawing funds from pensions may make this an unviable option. It may be necessary to instead explore whether life insurance can be obtained to meet the Inheritance Tax liability payable on the value of the unused pension held on death.
Pensions have often been used effectively in succession planning as a standalone Inheritance Tax free pot which can provide for one beneficiary, while the assets of the estate can provide for other beneficiaries.
It will therefore be important to review all pension nomination forms and Wills. This will help ensure the way the pension benefits and assets of the estate are allocated still achieve the succession planning aims and objectives when 40% of the pension funds will be lost to Inheritance Tax under the proposed new rules.
Business owners and SSASs
One far-reaching impact of the new rules could be for business owners who hold their company premises within a SSAS.
Inheritance Tax will be payable on this illiquid asset, but the usual rules for Business Property Relief, and the option to pay Inheritance Tax on bricks and mortar in instalments (usually over a 10-year period), will not be available to the assets held in the pension. If the Inheritance Tax liability cannot be paid within six months from the date of death, interest will accrue on the unpaid tax at a current rate of 7.75% until payment is made.
It will be important for business owners to fully review their SASS arrangements in the context of wider succession planning for the business. The pension scheme rules, any key person insurance, shareholders agreements and cross-option agreements will all interact to determine whether the business can continue as a going concern. They will also affect the availability of assets to settle any Inheritance Tax arising on death and the extent to which value can be released for family members and beneficiaries.
Hill Dickinson’s Succession Planning, Wills, Trusts and Estates team work closely with business owners and high-net-worth individuals to prepare and implement effective and tax efficient succession planning. Contact us today to discuss how we can support you with succession planning.
