On the face of it many will have been relieved by the Budget announcement on Wednesday on the grounds that, ‘it could have been worse’. The broadly anticipated changes to Capital Gains Tax and Business Relief on Inheritance Tax (‘IHT’) came as expected and without significant shock.
However, many will feel more aggrieved by the proposal that IHT is to be applied to unused pensions and death benefits from April 2027.
As Baroness Altmann, a leading pensions expert and political campaigner, has been reported to have observed, the changes announced by the Chancellor of the Exchequer, Rachel Reeves, will undermine the careful pension planning of many.
HMRC published a consultative document on the changes at the same time as the Budget announcement.
The document states that the aim of the measures announced in the Budget in making most unused pension funds and death benefits subject to IHT from 6 April 2027 is to, ‘align their tax treatment with other types of inherited assets…removing the incentive to use pensions as a tax-planning vehicle for wealth transfer after death.’
“At a stroke, Rachel Reeves has undermined the pension freedoms that were put in place by her predecessor…”
At a stroke, Rachel Reeves has undermined the pension freedoms that were put in place by her predecessor as Chancellor, George Osborne.
The introduction of these pension freedoms in 2015 removed a 55% charge for pensions funds that remained unused at death. Further, the abolition of the Lifetime Allowance by Reeves’ immediate predecessor, Jeremy Hunt, in March 2023 removed the cap on the amount of tax-relievable pension savings an individual can accumulate over their lifetime.
Additionally, most UK registered pension schemes are discretionary and are, therefore, currently outside the scope of IHT. Existing rules provide that unused pension funds and death benefits from discretionary schemes do not form part of an individual’s estate and are therefore not chargeable to IHT.
The combined effect of these measures has meant that individuals have been able to accumulate unlimited tax-free savings in their pension, draw on other means to fund their retirement and leave their unused pension assets to be inherited by beneficiaries without any tax payable.
“…‘use your pension last’, has now been turned on its head with the result that many will now be looking at ways of using their pension first…”
Following Wednesday’s Budget announcement, however, the planning orthodoxy of the last decade, in summary; ‘use your pension last’, has now been turned on its head with the result that many will now be looking at ways of using their pension first as a means of avoiding the new IHT charge on unused pension benefits, when it comes into force in April 2027.
The situation will be particularly challenging for those beneficiaries who inherit the pension from someone who dies post age 75 after the new rules come into force. Benefits paid in respect of someone who dies post age 75 already face an income tax charge under current rules. It now appears that this liability may be supplemented from 2027 by a charge to IHT.
Further, the IHT nil-rate band has been frozen at £325,000 for a further two years to 2030/31 meaning that many more estates will be paying IHT at the full rate, particularly when pension funds are brought into the calculation.
It is assumed, however, that pensions will still pass to spouses and civil partners without incurring an IHT charge.
Of course, steps can be taken to mitigate some of the effects of the proposed new charge; however, great care will be needed to avoid, for example, triggering income tax charges and/or running down pension funds to the extent that funding in retirement is compromised.
We would urge clients to talk with their wealth planner and not to take any peremptory steps. It should also be noted that the consultation period runs until 22 January 2025 – undoubtedly there will be intense feedback from interested and affected parties between now and then.