What is the true value of my pension (for inheritance tax reasons)?

Times

17 hours ago

Q. I understand pensions will be brought into the realm of inheritance tax (IHT) in the next couple of years but I wondered if there was any information concerning how the value of the pension will be assessed?
Other assets have a financial value which is easily understood. They may also be given away and, provided that the rules are adhered to, may avoid IHT.
I do not believe the same can be said for pensions. My understanding is that they cannot be given away during your lifetime, which is why the government is looking to include them within the IHT assessment.
The real value of a pension may depend on the tax treatment it will be subjected to. When a pension is assessed for IHT purposes, is it the full value of the remaining pension that becomes part of the estate for IHT?
Please note I live in Scotland — will this affect the income tax charged to my beneficiaries?Neil
As you note, from April 2027 the government has confirmed unspent pensions will count towards your estate for IHT purposes, meaning more people will be affected by the tax.
That said, despite IHT being one of the most unpopular taxes in the UK, it is levied on a minority of households — so it might not affect you at all. About 5 per cent of deaths result in any IHT being paid, though the inclusion of pensions may double this proportion.
You will need to exhaust your nil-rate band of £325,000 and main-residence nil-rate band of £175,000 (an extra allowance for those leaving their home to a direct descendant on estates worth up to £2 million) before any of your estate is exposed to an IHT charge of 40 per cent.
Furthermore, if your estate, including any pensions after April 2027, is being inherited by your spouse or civil partner, there will be no IHT to pay at all. And in general terms, it is best not to let the tax tail wag the pensions or investment dog.
To confirm, it will be the full value of your pension, before income tax, that is assessed for inheritance tax.
Tax, including IHT, is clearly a consideration when making retirement decisions, but it should not be the only consideration.
If you die before age 75 your pension, up to a limit of £1,073,100, can usually be passed without your beneficiaries having to pay income tax when they withdraw it. Above the limit they will pay tax at their normal rate.
If you die after age 75, your beneficiaries will pay income tax on all of the funds at their normal rate. These rules will still apply when defined contribution (DC) pensions become subject to IHT from April 2027.
For those unfamiliar with the jargon, a DC pension is a retirement pot where how much you build up is based on what you pay in and investment growth. Your contributions benefit from upfront tax relief, the growth is tax-free and your money available to access as you wish — with up to a quarter available to take tax-free — usually from age 55 (rising to age 57 from April 2028).
The alternative is a defined benefit (DB) pension, where you are paid an income for life, though these are increasingly rare as they are so expensive to fund. Where it can be passed on (usually to a dependant) this income will remain free of IHT when the rules change. Annuities, an insurance product that pays an income for life, which can sometimes be passed to a named beneficiary, will also remain IHT-free.
However, certain lump sum death benefits from defined benefit (DB) schemes will be subject to IHT from April 2027.
Broadly, any money left in a DC pension pot on death — whether it's untouched or has been put into 'drawdown' — will count towards your estate for IHT purposes.
IHT will only become a factor if passing it on to someone other than a spouse or civil partner and the total value of your estate exceeds your IHT nil-rate bands.
In terms of valuing these pensions, that shouldn't be a problem as they are all cash amounts (note that inherited DB or annuity incomes will not be subject to IHT).
On gifting, there is nothing stopping you accessing your DC pension and handing the money to loved ones. Provided that you live for seven years after making the gift, this money should be IHT-free.
On income tax, these proposals are UK-wide but it will be the income tax rate that applies to your beneficiaries in the country they live that will apply.
Income tax rates in Scotland are different from those in England and Wales, with a lower starter rate of 19 per cent on income between £12,571 to £15,397 a year, but a number of extra income bands and a top rate of 48 per cent on income above £125,140, instead of 45 per cent. Any beneficiaries living there could pay a higher tax bill if they withdrew a large sum in one year than if they lived elsewhere.