With the 2027 Inheritance Tax (IHT) changes hurtling down the tracks towards us, there’s no doubt that client conversations need to be on a higher, and more urgent, plane than in previous years.
In doing so, we collectively have the opportunity to create massive tangible value for both current clients and the generations that follow.
From 6 April 2027, unused defined contribution pension funds will be brought into scope of IHT.
The new rules will eliminate the distinction between discretionary and non-discretionary payments, making all benefits part of the estate.
IHT will be payable on the gross value of the pension funds immediately before death, before distribution or designation to beneficiaries.
With pensions representing many clients’ largest single asset, the scale of the challenge is clear: more estates are likely to be caught, meaning more people will face tax liabilities.
Advisers who act early to help clients understand and adapt to the changes will reap the benefits of deeper relationships and stronger trust
In fact, the average IHT liability is expected to increase by £34,000 when pension assets are included in estates.
For most advisers, this is driving a serious reappraisal of clients’ estate planning strategies and pension access strategies.
For many wealthy clients, pensions have traditionally been viewed as ‘first in, last out’, or possibly even ‘never out’! but from April 27, the second part of this premise will most likely be upended.
With this in mind, there are some important, practical steps to consider to get ahead of the changes.
Identifying and contacting clients in IHT scope
With the scope of IHT changing significantly, it will be important to understand who will be affected and how.
The new policy will affect anyone inheriting estates within the scope of IHT, including beneficiaries of unused pension funds or death benefits included in those estates, as well as their representatives, advisers, probate solicitors and pension scheme administrators.
In terms of hard numbers:
- Around 213,000 people will have inheritable pension wealth by 2027
- 10,500 will have an IHT liability by then, where previously they would not
- Around 38,500 estates will pay more IHT than would previously have been the case
Understanding which clients are likely to be affected and proactively contacting them to offer advice will go a long way in prompting conversations that may not yet have been considered.
These early discussions can help clients assess the impact on estate planning while considering mitigation strategies, and ensure that beneficiaries are sufficiently informed.
Cashflow modelling will play a critical role in not only helping to clearly communicate the potential impact of the changes, but also in illustrating the effect of behavioural changes under consideration to mitigate this impact.
Advice will be essential for all clients affected to ensure they are making informed decisions.
Integrating pensions into clients’ wider estate planning strategies
If an individual’s estate is below the nil rate of IHT (or they’re married/in a civil partnership) and the total of their estate exceeds £1m, then no additional planning is needed.
However, if the pension fund’s value pushes an individual into IHT thresholds – or materially exacerbates the potential problem – there’s serious value in reviewing planning options that will integrate pensions into holistic estate planning, protecting the pension as an asset and derisking the size of the IHT liability on death.
Some potential tools that advisers can draw upon include the following.
Gifting of pension assets
If clients were planning to use their pension as an intergenerational legacy planning asset, it may now be more appropriate to draw an income from their pension and use this to make regular gifts out of normal expenditure.
It is worthwhile using IHT form 403 to evidence an audit trail and demonstrate the regular nature of the gifting.
Third party pension contributions could also be considered as a useful planning tool to improve the income tax position of the family across the generations.
One-off lump sum gifts could also be made, but these would normally be classed as a Potentially Exempt Transfers.
Life insurance in trust
Depending on the client’s age and health conditions, a life insurance plan placed in trust can also offer a cost-effective solution for meeting the additional IHT liability, especially when reducing the estate is not feasible.
This also enables a quick and simple solution to meet the IHT liability and could therefore reduce the administrative burden on death and enable more of the pension asset to be retained in a tax-advantaged growth environment.
Withdrawing funds for increased spending in retirement
Many will now be considering withdrawing funds, particularly the tax-free cash entitlement, and spending these funds to minimise IHT – especially once they reach age 75.
Of course, by making this choice, they are accepting that there will be an income tax charge on amounts taken in excess of the tax-free cash entitlement.
Opening up conversations with the next generation
While clients may initially find them difficult, conversations about wealth transfer and inheritance will always work harder when the next generation is aware of plans and can see the value of advice first hand.
Almost one in three (33%) advised families use the same financial adviser as another generation of their family.
All parties stand to benefit from shared access to an adviser. Parents and their children gain support for their distinct financial planning needs and conjoined wealth management solutions that operate with a valuable understanding of both parties’ situations and objectives.
To support the onboarding of a second generation, advisers can also offer tiered service models that offer different levels of service, such as fee-based or more streamlined solution.
What comes next?
And so, as the IHT landscape shifts, advisers have a pivotal role to play in guiding clients through uncertainty.
Those who act early to help clients understand and adapt to the changes will reap the benefits of deeper relationships, stronger trust, and more resilient long-term plans.
The key will be starting those conversations now, before the changes start to bite.
All of this represents a unique opportunity for advisers to engage with wealthier clients, their beneficiaries and legal personal representatives and probate solicitors, to demonstrate the value of advice.
Gareth Davies is a pension specialist at Scottish Widows
