How will your pension be taxed when you die after April 2027?

Full transcript

This is what is said in the video, with the figures written as numbers. Timestamps open the video at that point. The narration uses a digital clone of Steve Hunt's voice. The words are his own.

0:00How will your pension be taxed after April 2027?

Today's question, how will your pension be taxed when you die after April 2027? I'm Steve Hunt, a Chartered Insurance Risk Manager and a Trust and Estate Practitioner. And I started my career in 1980. I answer the questions you ask. And this one is a big one because from the 6th of April 2027, an estimated £1 trillion of pension money comes within the scope of inheritance tax for the very first time.

0:35What changes on 6 April 2027

From the 6th of April 2027, all and any unused pension money, pension funds from personal pensions, self-invested personal pensions, SIPPs, and money purchase company pension schemes will become part of your estate and potentially taxable at 40% on your death. The usual spouse or civil partner exemptions apply, but those are strict and do not include common law partners.

1:07Worked example: £516,000 of tax on a £500,000 pension

I recently wrote an article on LinkedIn which you can see on screen and in the description below about the widow Miggins and her daughter Amy. In the article, it shows how Mrs Miggins inherited a half a million pound pension from her husband who died before April 2027 and the circumstances where HMRC can end up taking £516,000 because of that pension more than the amount he left to his wife.

Because he died before his 75th birthday, the whole lot could have been paid out tax-free. So, we've gone from £500,000 tax-free to £516,000 paid in tax. This is a severe case. Most families will pay far less and some nothing at all. And sorry, this will apply to middle management families living in Slough driving Kias. Not a Porsche in sight. I have spent nearly 50 years encouraging people to get a pension.

And I think what a waste when I dive into the weeds of this. From April

2:18One word: "notional"

2027, you may be taxed on an asset you do not legally own. Oh no, sorry. That is not strictly, technically true. You do own it. "Notionally." For one second before you die. One word changes everything. This time the word is "notional". Parliament needed a word for property you do not own that can still be taxed as though you do. And that is the word it chose.

It sits there in the 2026 Finance Act in Parliament's own brackets. One word and an estimated £1 trillion comes within the inheritance tax net. You see, for the government to make something you don't own subject to IHT, they had to change the law. The pension that is not yours that technically belongs to a trust mostly.

But that is another technicality becomes notionally yours for the one second before you die so that the government can tax you on it. So, what pensions are excluded from inheritance

3:27Which pensions are excluded

tax from the 6th of April 2027? Three main categories really. Widow's, widower's and other dependants' pensions from a defined benefit scheme, final salary or average salary. Death in service benefits, a late addition, a concession from the government, and joint life annuities bought in your lifetime, including the nominees' annuity. But that's a video in itself. A word of caution though, for annuities, guarantee periods or value protection are included in your estate.

4:09How the £516,000 adds up

So, how exactly does Amy end up having to pay more to HMRC than her dad's pension was worth in the first place? The maths is actually not that complicated. And there are three essential assumptions that would not be particularly out of place in 2027. And they are Mrs Miggins' estate without the pension was £2 million.

That Amy works for a bank on gross earnings of £100,000 a year and draws £24,000 a year from her dad's pension. And that when Mrs Miggins dies, she is over age 75. So first of all the inheritance tax due when the pension was added to her estate that took the estate over £2 million. For every £2 that the estate is over £2,000,000, £1 of the residence nil rate band is lost.

The mathematics is quite complicated. The effect is simple. The effect of that is that the fund is effectively taxed at a notional rate of 60% resulting in additional tax for Amy to pay of £300,000. 60% of £500,000. But here's a nuance that not a lot of people know, including experts in my field. The pension does not pay the tax that it's responsible for. The pension pays a proportion of the overall tax.

So the pension does not pay £300,000. The pension pays its proportion of the entire IHT bill. If the overall estate is £2.5 million and the pension is half a million, then the pension represents one fifth of the estate. The total tax due is the £300,000 on the pension element and 40% tax on the non-pension element being £1 million after allowances. So £400,000.

So the total inheritance tax due on this estate would be £700,000 and one fifth of £700,000 is £140,000, and that is the amount that the pension fund has to pay. So that leaves in the pension £360,000 and not the £200,000 the computations would suggest.

The problem with this is that because Mrs Miggins died over the age of 75 even though her husband was under the age of 75 the 75 year rule applies to Mr Miggins' old fund, which means that Amy has to draw the income from her dad's pension as income and is taxed for income tax.

And if she takes £24,000 a year, then because of the taper on her PAYE, she loses £1 of her personal allowance for every £2 of income above £100,000, which effectively means that that £24,000 that she draws from her dad's pension is also effectively taxed at 60%.

And if she continues to do that for the next 15 years, also assuming no growth in the fund and tax allowances stay as they are, then that would result in a further 60% tax on the remaining £360,000 fund, being a further £216,000 in tax added to the original £300,000 the pension was responsible for in the first place.

It's a total of £516,000, £16,000 more than the tax-free pension he originally left when he died. And having deemed the pension yours for the second it takes to tax it,

8:13No business or farm reliefs, and a six-month deadline

the government's own technical note then confirms three separate times that you are not treated as owning the pension's assets. That is the sentence it uses to refuse business property relief, agricultural property relief, loss on sale relief, and the 10-year instalment option. So, the farmer's family and the business owner's family can pay the tax on the farm and the business over 10 years.

Mrs Miggins' family must settle the tax on the pension by the end of the sixth month after the month in which she dies with interest running after.

8:57The answer in three lines

So, how will your pension be taxed when you die after April 2027? An estimated 1 trillion pounds of pension money comes into the inheritance tax net for the very first time. Your pension fund will form part of your estate on death, but that does not include a spouse's pension from a final salary scheme, death in service benefits, or joint life annuities, including nominees' annuities. And by how much?

If your estate with your pension fund is under the nil rate bands, it will not pay inheritance tax at all. That's £325,000 plus up to £175,000 for your home each up to £1 million for a married couple. But if you are Amy, you could end up paying more in tax than the pension is worth. £516,000 on a £500,000 pension.

For every pound her dad put away, the family could hand over £1.03 to the taxman. And not even George Harrison had that. The nominees' annuity will be the subject

10:11What's next, and Roy Jenkins

of my next video. And I will leave you with those famous words from Roy Jenkins that are as true now as they were back in 1986. When talking about inheritance tax, he said that it was a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.