What is Inheritance Tax?
In the UK, Inheritance Tax (IHT) is a tax on the estate (property, money, and possessions) of someone who has died. There is generally an exemption on any transfers to a spouse (Spousal Exemption). However, when it comes to other beneficiaries, currently the first £325,000 of the deceased’s estate (referred to as the ‘nil rate band’) is exempt from IHT, with anything above this being taxed at 40%. An additional £175,000 allowance applies if the main residence is passed to direct descendants and further exemptions and reliefs can apply over and above this.
Do pensions fall into an individual’s estate for IHT?
Significant changes are coming.
Whilst pensions do not currently form part of an individual’s estate for IHT purposes in the UK, provided certain conditions are met, this will soon not be the case.
From 6 April 2027, most pension scheme death benefits together with any unused pension funds will be included in the deceased’s estate for IHT purposes. This move, to ensure that pensions are primarily used for retirement income rather than as a vehicle for wealth transfer, brings a considerable number of estates into the realms of IHT and is expected to raise substantial revenue for the UK Government in the coming years.
What does this mean for individuals with UK pension savings post 6 April 2027?
Post 6 April 2027, the value of a person’s pension fund will be added to their total estate value. This means if the value of the combined estate (including pension savings) exceeds the available nil-rate band (£325,000), IHT at 40% may apply (noting Spousal Exemption and other exclusions).
Does this apply to people living outside of the UK?
The short answer is yes.
If an individual’s pension fund is UK based, it will fall under their estate for IHT purposes, regardless of where they are living.
However, recently a new non-residency status rule replaced the previous domicile rule which creates opportunity for individuals who have moved away from the UK.
Under this new rule, an individual who has been resident outside the UK for at least ten of the last 20 years at time of death will be classed as a non-UK resident for IHT purposes so provided their assets (including pensions) have also been moved out of the UK, their estate will not be subject to IHT.
It is important to re-emphasize that simply achieving non-residency status will not remove an individual’s estate from the scope of IHT. If they have UK situs assets (including pensions) these will still fall into their estate for IHT and therefore will be taxed at 40% - if the total value of UK situs assets exceeds £325,000.
What does this mean for individuals with non-UK pension savings?
Individuals who have been resident outside the UK for at least ten of the last 20 years will be classed as a non-UK resident for IHT purposes so their non-UK pensions savings will not be subject to IHT.
This includes:
- Individuals who have moved away from the UK and stayed away (for ten of the last 20 years)
- Individuals who have been living away from the UK, returned, and died within their first ten years of returning
Who pays the IHT due?
In most cases (other than where a beneficiary must pay tax on large gifts where the deceased has died within seven years of the gift), the deceased’s estate pays the IHT; this means the executor or administrator of the estate. This is normally paid out of the assets of the estate before distribution to beneficiaries.
What does this mean for pension administrators and/or trustees?
As things currently stand, the deceased’s estate receiving money from the pension maybe subject to income tax on the pension withdrawal. If the estate value is greater than the nil rate band, it would also be subject to IHT - essentially potentially resulting in double taxation. HMRC are currently looking into the mechanics of this, and more detail is expected by the end of 2025. However, it is likely that the IHT payment will have to be made by the pension trustee before distribution to the estate or beneficiaries. This will likely put greater responsibility on pension scheme administrators, firstly to establish the deceased’s residency status for IHT purposes, and secondly to pay any IHT due on unused pension funds and report to HMRC.
Examples - Isle of Man (IOM)
Let’s use a couple of IOM residents as examples.
The IOM is not part of the UK for tax purposes as it has a separate tax system, with no IHT, no capital gains tax, and differing income tax rates to the UK. However, despite that, UK tax rules (particularly IHT) may still apply to UK situs assets, even if an individual lives in the IOM.
Example 1: Individual who moved to the IOM 30 years ago
Jenny is an architect who moved to the IOM from the UK 30 years ago. She has her own business on the Island and pays into an IOM self-invested personal pension (SIPP). She has no plans to move back to the UK. She has a pension scheme from the job she had with an architectural firm in the UK before she moved to the IOM. As it currently stands, this UK pension scheme will be included in her estate for IHT purposes.
Example 2: Manx Individual who works for a UK company
Tim has lived in the IOM for his entire life. Since leaving school, he has worked for a financial services company, working his way up the ranks to Senior Manager. His employer’s head office is in the UK and his employee pension scheme is a UK pension scheme. Despite the fact Tim has never lived in the UK and his residency status is non-UK, his pension scheme is in the UK and therefore falls within the scope of UK IHT upon his death.
What impact will this have?
At this stage it is difficult to predict what impact the changes to IHT will have, but we can speculate that we may start to see the following movements or trends:
- UK based individuals whose estate now falls into the scope of IHT, might choose to start gifting money to their beneficiaries sooner rather than later (bearing in mind IHT restrictions around gifting). Or perhaps they’ll just decide to take that holiday, make that home improvement or buy that new car!
- Perhaps we’ll see those who want to ensure their wealth is passed down retiring outside of the UK to alternative jurisdictions with different tax regimes (such as the IOM) and moving their assets with them.
- Conversely, people who have moved away from the UK, may now decide to move back to live out their final days now that their assets will not fall under the scope of IHT (provided they don’t live longer than 10 years!)
- It is highly likely that non-UK residents who have no plans to return to the UK will make plans to move their assets offshore, specifically in respect of pensions
What’s next?
In short, if you live outside the UK and have a UK pension, or suspect you might have a UK pension, talk to your adviser about the impacts this change may have on you.
John Batty
Technical Sales Manager
