Pension pots and Inheritance Tax – changes in 2027

When the current form of IHT started in 1986 the ‘nil rate’ threshold before tax applied rose annually with inflation. However, a freeze in 2009 fixed the threshold at £325,000. In 2017 a new ‘residence’ nil rate band added an allowance for homes passed to a direct descendant. This started at £100,000 and now stands at £175,000. The 2024 Autumn Budget confirmed the freeze for both the £325,000 and £175,000 thresholds until 2030. In effect this means that couples can leave up to £1million to children, stepchildren, and grandchildren. However, rising property prices and frozen thresholds mean more families will pay IHT. 

 

IHT doesn’t currently apply to pension savings and related death benefits. Many people have used other assets in later life so they can pass on their pension without IHT. Currently, if someone dies before the age of 75 their unused pension can pass to the next generation tax free. Beneficiaries of someone over 75 pay income tax on lump sums or income they receive from an inherited pension pot. 

 

From 6 April 2027 the government plans to include unused pension pots in people’s estates when they die. In addition, from April 2026, the IHT rules will change for farmers and business owners. The amount they can leave before IHT will have a £1million limit per person, with 50% relief on the remainder. For example, for an estate of £2million this means the first £1 million is free of IHT. Relief of 50% on the remaining £1million means tax at 40% on £500,000, creating a new tax liability of £200,000. 

 

The government’s consultation ended in January and the next step is draft legislation later in 2025. 

 

The proposals could still change but it’s worth considering how they could affect your family. You have an allowance for gifts each year of up to £3,000. You can also give small annual gifts of £250 to as many people as you wish such as grandchildren. If your grandchildren marry, you can give them each a tax-free gift of up to £2,500. 

 

You can also give gifts from regular income if it doesn’t affect your standard of living. This leaves your estate immediately, so IHT won’t apply. For example, you could contribute a monthly amount to a tax-friendly Junior ISA for each of your grandchildren. 

 

You can also make other gifts without incurring IHT if you live for seven years afterwards. If you die within seven years IHT applies on a sliding scale. 

 

Setting up trusts can also minimise IHT and allow you to stay in financial control during your lifetime. After seven years, you don’t own assets you’ve transferred into a trust, so they aren’t part of your estate when you die. However, different tax rules apply, so you should take some advice before taking this step.