Understanding Investments – Pension Taxes on Death
Friday 28 February, 2025
In the October 2024 Budget, the Government proposed upcoming changes to the way pensions will be taxed on death. From April 6th 2027 pension values are likely to be included in estate value for Inheritance Tax purposes.
There is an ongoing consultation on the way this will be administered. Once fully known our financial advisers will provide further information.
What do the changes to pension taxes on death mean?
If your total estate including pension values is under your IHT allowances then there is no change to the way they are taxed currently. This will only affect clients whose estates exceed their IHT allowances when including pension assets along with all other assets. For this article we are focusing on pension taxes only and not wider IHT rules.
Death Pre Age 75:
Inheritance tax applies unless the nomination on death is to a spouse or charity. There is no income tax charge or lump sum charge unless the proceeds exceed the Lump Sum Death Benefit Allowance (LSDBA) of £1,073,000. The Lump Sum Allowance (LSA) of £268,250 still applies to tax free cash.
Death post age 75:
As above, other than the fact that an income tax charge would also apply at the beneficiary’s marginal rate of tax. This could mean that two tax charges will apply – IHT and income tax on the beneficiary.
The ability to control the way income is paid out to the beneficiary could be very important to mitigate the tax rate paid. For example, if a pension provides only for a lump sum death payment and is valued at, say, £150,000, that is added to the beneficiary’s income in that tax year. As a result, part of the payment would then be taxed at additional rate tax and higher rate tax. Under beneficiary drawdown the beneficiary can choose the level of income they draw out and do this over a number of years to control the income tax charge. Many pension plans don’t offer beneficiary drawdown so this should be checked. We also recommend seeking the advice of an accountant for tax calculations/liabilities should they apply.
A change in the way wealthy clients treat pensions?
Pensions are still very tax-efficient saving vehicles. You receive tax relief on the way in, money then grows tax free, and on the way out you receive a lump sum tax free with the remainder taxable at your marginal tax rate (often lower than the tax you saved on the way in).
Many clients will still need their pensions to pay for their own retirement needs and will draw money out from them via drawdown or the purchase of an annuity. In this case client behavior is less likely to change due to a potential IHT charge on death.
The changes do affect clients who have surplus assets for their own needs and up to now had expected to leave their pension pots to their children or grandchildren IHT free. It’s those clients who need to review their planning as the tax rate on death post age 75 could be as high as 67% (assuming the pension is liable to IHT and the beneficiary is not a spouse or charity and is an additional rate tax-payer).
Seek advice to plan effectively
“The positive news is that there are multiple planning strategies available to mitigate these changes, but it’s important to act now,” says Howard Goodship, Independent Financial Adviser at Lonsdale, Ringwood. “Every individual’s situation is different, and tailored advice can help ensure pensions remain an effective part of your estate and tax planning strategy.”
Lonsdale independent financial advisers offer a free, no-obligation initial chat to discuss your personal situation and explore the best options for you.
Howard Goodship is an Independent Financial Adviser with Lonsdale Wealth Management, Ringwood.
A pension is a long-term investment not normally accessible until age 55 (57 from April 2028). The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change.
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