Employers are being urged to prepare for and proactively support employees with significant changes to the way pensions are to be treated under Inheritance Tax (IHT).
This warning comes from WEALTH at work a financial wellbeing, retirement and workplace savings specialist.
As tax rules stand, when someone dies, the first £325,000 of their estate is tax-free under the Nil Rate Band (NRB).
If they leave their home to direct descendants, they may also benefit from an extra £175,000 tax-free allowance called the Residence Nil Rate Band (RNRB).
However, for estates worth more than £2m, the RNRB is gradually reduced and can be lost entirely.
From 6 April 2027, unused defined contribution (DC) pensions will be included in an individual’s estate for IHT purposes.
This means that if someone dies with pension savings still in place, those funds could be taxed at 40%, just like other assets such as property or investments. For families with large estates, especially where the RNRB is tapered away, this change could result in a combined tax burden of up to 87% on unspent pension savings.
Other key changes to IHT on pensions are:
- Personal representatives (those managing the deceased’s estate) will be responsible for declaring and paying any IHT due, rather than pension scheme providers.
- Provider support – Pension providers must still supply relevant information to assist with IHT reporting.
- Certain benefits remain exempt, including lump sum death-in-service benefits, joint annuities, dependants’ pensions and charity lump sums.
For estates that have already used their nil-rate bands, the pension pot will be taxed at 40% IHT. Additionally, if the deceased was over 75, beneficiaries will also pay income tax on withdrawals at their marginal income tax rate. This combination can result in an effective tax rate of up to 67%.
WEALTH at work director Jonathan Watts-Lay said: “The introduction of IHT on pensions could result in substantial tax charges for some. Those most likely to be affected are individuals with larger pension pots, especially if those savings were intended to be passed on to family.
“Rising living costs, longer retirements, and care expenses could mean that many pensions are used up during retirement, so it won’t be an issue for all. However, for those with additional savings beyond their pension, a shift in thinking and strategy could be beneficial. From an IHT perspective, it could now be better to spend pension savings first and preserve other assets for later on.
“This is the opposite approach to what has previously been the case. That said, people will need to review their individual circumstances. As a result, employees may seek guidance and advice on how these changes affect their retirement and estate planning, meaning that financial education, guidance and advice around pensions and tax implications will become increasingly important.”
“These changes represent a significant shift in how pensions are treated for tax purposes. Employers play a vital role in helping employees understand the implications and take action to protect their financial future. For now, the focus should remain on helping employees make the most of their pensions and lifetime savings for retirement. As we approach 2027, employers will need to ensure they have the support in place to help employees understand how they can minimise tax liabilities due to the changes to IHT. Financial education and guidance in the workplace can help employees review their situation.
“Many employers also provide employees with access to regulated financial advice. This can help those who need it take the appropriate steps to reduce IHT by adjusting how they draw their pension or using other tax-efficient strategies. Putting in place robust processes is key to improving retirement outcomes for all.”
WEALTH at work advised that even though the rules are still in draft form, employers are encouraged to stay informed and monitor legislative updates and encourage staff to review pension nominations and estate plans.
As well as work with pension scheme providers and retirement specialists to ensure employees receive appropriate support.
