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Pension and inheritance tax reform explained.

Are you prepared?

Significant changes are on the horizon for UK pensions and estate planning.  Pension funds will soon be included in your estate for UK inheritance tax purposes – a reform that could dramatically increase the tax burden on your heirs. Are you prepared?

Historically, UK pension funds have generally been exempted from UK inheritance tax (IHT) when passed on to beneficiaries – but this is changing. From April 2027, any unused funds and death benefits will form part of your estate for IHT purposes.

This reform is expected to impact hundreds of thousands of British families. Íæż½ã½ãriates are also affected, regardless of how long they’ve lived abroad.

How does this impact your family?  A case study

How much more tax will your children pay?  Here we look at a typical British expatriate couple living in Cyprus (though it also applies to other countries as well as UK residents). If their situation resonates with you, act now to protect your family and heirs.

John and Jenny moved from the UK to Cyprus in 2023 when John retired. They opted to keep their £500,000 UK property, which had been their family home since the children were young, as they visit a few times a year to spend time with family and friends. They would also like to leave it to their daughter eventually.  They used some of their savings to buy their new Cyprus home, worth £350,000, and left the £260,000 balance invested in the UK.  John also has a Self-Invested Pension Fund (SIPP) worth £720,000.

At present, their total estate liable to inheritance tax is £1,110,000 since John’s SIPP is excluded. Their combined nil rate bands (personal and residential) amount to £1,000,000, so their taxable estate is £110,000.

Today, with pensions excluded, their tax liability is £44,000.

However, from April 2027, their financial situation will change significantly. John's £720,000 SIPP will be added to their estate, bringing the total value to £1,830,000. Their IHT allowances, however, remain at £1,000,000.

In 2027, with pensions included, the resulting IHT liability is £332,000 – a 655% increase.

This case study is for illustrative purposes only and has been simplified.

Other pension taxes on death – total tax up to 67%

When the balance of your pension fund passes to your beneficiaries, they may face income tax at their marginal rate (up to 45%) as well as the 40% inheritance tax.

If your beneficiaries take the death benefits as a lump sum, any amount over £1,073,100 (or lower if you previously took other lump sums), will be taxable regardless of your age of death. If they take the benefit as pension income, they will pay income tax if you die after age 75, but zero income tax if you die younger than this.

This can have a significant impact on how much your heirs actually benefit from your pensions. Using John’s SIPP as an example:

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UK inheritance tax, long-term residence and expatriates

The abolition of the domicile regime was a welcome reform for expatriates. The replacement long-term residence rules not only provide more clarity for inheritance tax, but many more families will now only be liable on UK-situated assets and not on worldwide wealth as previously. 

UK pension funds, though, are of course UK assets. Unless you are in a position to move your funds overseas, the 2027 reform could have significant implications for your estate.

Protect your family | ACT NOW

Whether you live in the UK or overseas, now is the time to establish exactly how your family will be affected and if there is anything you can do to protect them.

There are planning options available to mitigate the impact, but much will depend on the type of funds, country of residence, what other investments you have, your risk tolerance, plus your family situation, objectives, time horizon and plans for the future. Professional, specialist advice is essential here, as you need to protect your retirement income as well as reduce tax for your heirs.

Be aware that pensions paperwork is complex and time-consuming. For example, obtaining a Non-Taxable (NT) code from HMRC and completing the necessary paperwork is currently taking around nine months. While 2027 may seem some way off, in pension terms it’s not that far at all.

Delaying action could leave your family exposed to a significantly higher tax bill.  Seek advice and start exploring solutions now.

Source Blevins Franks