Skip to content
Mercia-Fund-Management-colour-logo
Get in touch

Inheritance tax on pensions

Your clients will have a new large IHT liability from April 2027

>>This page is for investment professionals only<<
Mercia EISNorthern VCTs
Understanding your client's IHT liability from April 2027¬
BOOK A MEETING
Pensions now

For many years, pensions have been outside of Inheritance Tax, and have been the main strategy for the UK population building long-term wealth.

Currently, for example, a £3.5m pension has no IHT liability, but income tax is payable for the beneficiaries.

The net distributed amount is £1.925m, with a 45% effective tax rate.

Pensions after 2027

The loophole of using pensions for legacy planning is being closed. After April 2027, pensions will be included in the IHT estate, and proceeds will also be taxed as income.

For the same £3.5m pension after 2027, there would be a 40% IHT charge, and descendants would also incur income tax.

The net distributed amount would be £1.155m, with a 67% effective tax rate.

Strategies to mitigate IHT on pensions:

  • Gifting and trusts❓

    • Issues include the lack of control, access to capital and complexity
    • It is currently unclear whether pension capital can be regularly released and gifted from excess income

  • Whole of life insurance❓

    • The premiums will be very expensive, if possible
    • A 80-year-old with a £3.5m pension, would pay £64k pa to cover the additional tax, or £176k pa to cover the full tax liability
    • Whole of life insurance is unlikely to be available for clients over 80, smokers, or clients not in perfect health

  • Tax-efficiently reinvest pension capital, via*:

EIS - 32% effective tax rate¬
VCT - 49% effective tax rate¬
BR funds - 56% effective tax rate¬

Considerations

Your clients will have a large additional IHT liabilty from April 2027

increased IHT liabilities range from £4k (£0.5m pension) to £2.32m (£10m pension)

Reallocating pension capital takes time and complex planning

We can provide you with options to manage your clients IHT

Strategies to mitigate IHT on pensions*:

pension1

Status quo

If no action is taken, two-thirds of your client's pension will be lost in tax, first through IHT and then through income tax to the descendants (64% for a 40% marginal tax rate, as per the AI illustration).

There is powerful drive for your clients to take your advice, and many new HNWIs will be seeking advice.

Explore more¬
move to br1

BR replaces pension

Other than gifting, and assuming whole of life insurance is too expensive (/not possible), then investing pension capital in BR funds could be considered.  

Productised BR funds are available, aiming (not always succesfully) to offset inflation (no growth), but improtsantly to provide monthly liquidity.  

Explore more¬
move to vct

VCTs provide income

VCTs are not BR qualifying, but benefit from 30% income tax relief,  which can offset the income tax liability triggered when releasing pension capital.  On a basic level, this can make VCTs more tax-efficient than BR! 

Clients are limited to investing £200k pa, but interestingly, the c5% dividends are paid tax-free, and a comparable taxed income would need to be 9.1%! 

Explore more¬
move to eis1

EISs are very tax-efficient

From a tax-efficiency perspective, EISs are the most attractive, with a range fo benefits.  However, EISs are the most volatile and illiquid option.  

If the client understand the risks, the income tax relief, BR qualification and downside protection are very attractive. 

If the EIS is well managed, the returns can be very attractive. Capital is at risk and is totally illiquid.  

Explore more¬

Time until your client gets a significant IHT liability

Understand the IHT dynamic between age at death, 75 is a cliff edge¬
Preferential IHT treatment of married couples¬
Consider the marginal income tax rate of the descendants¬

Independent opinions

Model of pension reallocation to a mixture of tax-efficient strategies, including EIS, VCT and BR

Please use our model to investigate the impact of releasing pension capital, assuming no tax-free lump sum or phased withdrawal. 

The model shows the benefits of EIS and VCT versus BR investment, partially driven by the availability of 30% income tax relief. 

Explore the model¬
BOOK A MEETING

 

* This simplifies the situation, as it does not account for the £1m BR allowance, nor does it account for the gross/net impact of fees, or the timeline for extraction and deployment. 

¬ External sites are AI-generated, via Claude from Anthropic, are partially manually checked, but cannot be entirely relied upon.  We are providing this information to you as an investment professional, to make your best judgment.  References are shown in some cases.