The changes in pensions inheritance tax for clients

20 Feb 2025

First seen on Money Marketing

Inheritance tax is a highly emotive and poorly understood subject. The general noise around unused pension pots being brought into inheritance tax – since the surprise announcement in last Autumn’s Budget – will no doubt have prompted many discussions with clients. The new rules may well change people’s attitudes to their retirement and estate planning. But a lot could happen between now and when they are due to come into effect.

The Chancellor announced that from 6 April 2027 leftover pension pots will become liable for inheritance tax after the death of a member. It’s a large change for a small number of people. By 2029, when the money will be flowing through fully to the Treasury, it’s estimated to bring in an additional £1.5bn annually.

But for the vast majority it will make no difference. The change will lead to just 1.5% of UK deaths starting to pay IHT where they didn’t before and 4.5% of UK deaths having to pay more inheritance tax than they were previously. The average additional tax raised from those paying it will be a little under £40,000 each.

Financial Advice for Inheritance Tax

Of course, many of those likely to be affected are probably people who already pay for advice. Or they could be prompted to do so if they want to get a better understanding of what it will mean for them.

While they will want to consider their options and talk through appropriate action with you, they shouldn’t rush to make drastic changes. A logical analysis would suggest that as most people will be unaffected it shouldn’t change general behaviours in the way pensions are used.

However, I’ve already been pulled up in a client meeting for saying “unused pension pots can be left to the next generation” and told “you mean left to Rachel”.

The technical consultation seeking views on the processes and reporting requirements needed to implement this change has not long closed. The government is reviewing the issues and views expressed in responses, and plans to publish both a formal response and draft legislation later in the year.

Then we will have to get to grips with how it will work. Advisers will consider the implications for clients and will be on hand to give the appropriate recommendations based on individual scenarios.

The effects of the new Inheritance Tax rules

For those that are affected by the change, it’s worth remembering that the new rule will have two effects. Firstly, it will increase their total inheritance tax liability. And secondly it will mean that some of the inheritance tax bill will have to be paid from pension assets. So, we are really dealing with two inheritance tax changes, rather than one.

The prospect of a larger inheritance tax bill will be the catalyst for more people to think about their finances. The easiest way to reduce the possibility of IHT liability is to spend more. Take more holidays. Fly first class rather than business or economy class if visiting relatives in America or Australia.

Or there’s the option to give money to the next generation now, especially if current health suggests the client is likely to live the necessary seven years to make lifetime transfers fully exempt. We may also see greater use of IHT-friendly investment schemes or buying life assurance that will pay the eventual IHT bill.

The second issue of where the inheritance tax is going to be paid from is more interesting. It could be helpful for those who, like farmers, have high levels of assets with very low liquidity.

With some of the inheritance tax liability falling on the pension – which I’m assuming is highly liquid – it may ease the pressure to sell fields and tractors that even the giant supermarkets are saying is threatening our national food security.

On the other hand, having part of your nil-rate band being allocated to pensions wealth is an inefficient use of it. To use any of the valuable nil-rate band on pensions that are sitting in a gross environment is fiscally wasteful. Better to use it on assets that were purchased with income that has already been taxed.

The consultation on administering the proposed changes spurred the chief executives of AJ Bell, Hargreaves Lansdown, Interactive Investor and Quilter to write to the Chancellor in united opposition.

They’re not objecting to the principle, but to the complexity of the administration. They believe there are better ways to achieve the policy aim. When those running £430bn of investments for 3.4 million customers speak up, we must expect the Chancellor to listen.

Inevitably a different way of raising tax from pension pots will impact different people in different ways. So sensible planning right now is very difficult, but planning will always be valuable.

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