Practical steps to get ahead of IHT and pension changes

With just a year to go, we take a close look at the IHT changes which will pull unused DC pensions into scope from April 2027 and transform intergenerational wealth planning advice.

With the 2027 Inheritance Tax (IHT) changes coming towards us at full speed, there’s no doubt that client conversations need to be on a different (and more urgent) level this year. But with such a big change, the industry has a new opportunity to create tangible value for both clients – and the generations that follow.

From 6 April 2027, unused defined contribution pension funds will be brought into scope of IHT. Currently, most pension funds are outside the estate because they are paid at the discretion of the pension scheme. The new rules – just over 12 months away – will remove 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 people are going to be facing tax liabilities. The average IHT liability is expected to increase by £34,000 when pension assets are included in the value of the estate.

For most advisers, this is driving a serious reappraisal of clients’ estate planning and pension access strategies. For many wealthier clients, pensions have traditionally been viewed as first in, last out (or possibly even never out), but from April 2027 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 and ensure clients’ needs will be met.

With the scope of IHT changing, it will be important to understand not only how these reforms will impact people, but who they will affect.

The new policy will affect all individuals inheriting estates within the scope of Inheritance Tax (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 hard numbers:

• The Government estimates¹ 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 Inheritance Tax than would previously have been the case.

Understanding which clients are likely to be affected and proactively contacting them to offer advice and guidance will go a long way in prompting conversations that many may not yet have 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 undoubtedly play a critical role in not only helping to clearly communicate the potential impact of the changes but will also help to illustrate the effect of behavioural changes under consideration to mitigate this impact. Advice will be essential for all clients affected, to ensure that they are making informed decisions.

If an individual’s estate, including the value of their pension funds, is below the nil rate band of inheritance tax (or they’re married or in a civil partnership) and the total of their estates including the pension fund does not exceed £1m, then it could be that no additional planning is needed.

However, if the pension fund’s value pushes an individual into IHT thresholds – or materially exacerbates the potential problem to a level where it deserves serious attention – there’s real value in reviewing options that will integrate pensions into holistic estate planning strategies; protecting the pension as an asset and derisking the size of the IHT liability on death.

Some of the potential tools advisers can draw upon include:

• 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 (PETs).
• 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, enabling more of the pension asset to be retained in a tax-advantaged growth environment.
• Withdrawing funds for increased spending in retirement: There will be many who will now consider withdrawing funds (especially the tax-free cash entitlement) and spending these funds to minimise inheritance tax – especially once they reach age 75. Of course, by making this choice, the member is accepting that there will be an income tax charge on amounts taken in excess of the tax-free cash entitlement.

The average IHT liability is expected to increase by £34,000 when pension assets are included in the value of the estate.

In addition to the potential inheritance tax that could be paid on the client’s unused pension fund on death, the scale of the additional administration burden that this could present should not be underestimated. Advisers could help to ease the future workload on beneficiaries and legal personal representatives by considering consolidation of legacy pension assets, where appropriate.

This could help to simplify the future administration burden on client’s families and also on their advisers and legal personal representatives.

While some clients may 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%²) 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 an understanding of both parties’ situations and objectives.

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 is to start those conversations now. 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.