Inheritance Tax net to catch defined contribution pensions

The Chancellor’s Autumn Budget contained at least one positive for private pension plan holders: widespread rumours of a reduction in amount of tax-free cash that can be withdrawn from a pension proved unfounded (at least for now).
However, there was bad news for defined contribution pension plan holders who have been intending to leave their unspent pension savings to children or grandchildren, with the announcement that, with effect from April 2027, such pensions will be subject to inheritance tax (IHT) on the pension holder’s death. The existing exemption where the pension passes to a spouse or civil partner will continue to apply.
Broadly speaking there are two main types of private pension:
- defined contribution (sometimes also referred to as ‘money purchase’) – where the pension pot is based on how much is paid in; and
- defined benefit - usually a workplace pension where the amount paid out depends on, for example, final or average salary and length of membership of the employer's scheme.
Currently defined contribution pension plans are generally exempted from IHT on death.
Many defined contribution pension plan holders will have maximised their contributions over the years with the specific intention of building up a tax-efficient pot for their descendants to inherit. They may have based their whole retirement and succession planning arrangements on the assumption that their pension assets will be sheltered from IHT.
The Government’s Budget press release described the taking of such steps as “a distortion which has led to pensions being used as a tax planning vehicle to transfer wealth rather than their original purpose to fund retirement”.
Holders of defined contribution pension plans would be well advised to review their affairs carefully during the window before April 2027. Retirement and succession planning arrangements overall should be revisited for tax-efficiency. Arrangements currently in place may need to be unpicked. Wills and/or letters of wishes should be reviewed and, where appropriate, amended.
Fears of an assault on the ‘seven-year rule’ did not materialise in the Budget. Some pension holders may decide to withdraw funds from their pension pot with the intention of making lifetime gifts to children or grandchildren and then surviving seven years. It is to be hoped that this will not lead pension plan holders to raid their pension pots with the result that they end up with insufficient resources to support themselves during a retirement which could last a very long time.
As always, pension plan holders considering their position should obtain appropriate professional advice.