When did you last check who you’ve nominated to receive your pension when you die?
For many people it was probably when they first joined the scheme and you may have completed he expression of wishes form and then forgotten all about it.
Until now, that hasn’t mattered too much for Inheritance Tax, because unused pension pots have generally sat outside your estate.
However, that is about to change from April next year and the name on that form could make a real difference to how much your beneficiaries receive after tax.
What is changing in April 2027
As we have reported before, from 6 April 2027, most unused pension funds and pension death benefits will count as part of your estate for Inheritance Tax.
The Government estimates that in 2027/28 around 10,500 estates will face an Inheritance Tax bill for the first time as a result, while roughly 38,500 will pay more than they would have done.
How much more? Well, for those estates, the average liability is expected to rise by about £34,000. This isn’t an insignificant amount and could significantly impact your beneficiaries.
However, some benefits sit outside the new rules, including death in service payments from a registered pension scheme.
Similarly, dependants’ scheme pensions from defined benefit schemes aren’t included in the value of your estate.
For most people with a SIPP or a workplace defined contribution pot, though, the unused balance will be caught.
Why the beneficiary matters
The existing exemption for assets passing to a surviving spouse or civil partner still applies to pensions.
If your pension goes to your spouse or civil partner, there will normally be no Inheritance Tax to pay on it when you die.
Leave the same pot directly to a child and the position changes. The pension is added to the rest of your estate and anything above your available nil-rate bands is taxed at 40 per cent.
If you die after 75, your beneficiaries already pay income tax at their own marginal rate when they draw on an inherited pension.
That rule hasn’t changed, so from April 2027 the same money could be hit by both forms of taxation.
As a simple example, suppose your estate is already above the nil-rate band and residence nil-rate band, you die after 75 and you leave a £200,000 pension to a child who is a higher-rate taxpayer.
This could generate an Inheritance Tax bill of £80,000. If your child then draws the remaining £120,000 over time, they could pay Income Tax at 40 per cent on it, a further £48,000.
In total, your £200,000 pension could be whittled down to just £72,000, an effective tax rate of 64 per cent.
The case for naming your spouse
For many married couples and civil partners, naming each other as the first beneficiary will now make more sense than going straight to the children.
No Inheritance Tax is due on the first death and your unused nil-rate band can pass to your spouse to use later.
A surviving spouse can draw an income from the pension or make gifts to the family over time, planning their own estate with the full picture in front of them.
Those choices are no longer available once the pot has gone directly to a child and the tax has been paid.
It isn’t one size fits all
Naming your spouse defers the tax rather than removing it and so whatever remains when they die may form part of their estate, so it’s important to plan for both of you together.
If your spouse already has a large estate of their own, adding your pension to it may not help.
The spouse exemption can also be capped where your spouse or civil partner is not a long-term UK resident and for some families, a trust or a different split between beneficiaries may give a better result.
During your planning, you must remain mindful that adding a pension can push an estate’s value over £2 million, at which point the residence nil-rate band starts to taper away.
The taper is based on the estate’s value before exemptions, so it can apply even where everything passes to a spouse.
What to do now
April 2027 is closer than it sounds and here are simple checks to make now:
- Track down every pension you have, including old workplace schemes you may have forgotten about.
- Ask each provider who is currently nominated and get a copy of your expression of wish form.
- Think about whether your spouse or civil partner should now be the first beneficiary, with children named after them.
- Make sure your will and your pension nominations work together rather than against each other.
- Revisit your nominations after any big life change, such as marriage or divorce.
Take advice before you change anything, as the right answer depends on your age and other assets as much as on what you want for your family.
We can review your pensions alongside the rest of your estate and help you work out the most tax-efficient approach for your family, so please get in touch.
