There’s a quiet but significant shift happening in the world of Inheritance Tax (IHT) and it’s one that could catch far more families than many realise.
For years, pensions have been one of the most effective ways to pass on wealth. Kept outside of your estate for Inheritance Tax purposes, they’ve often been the last pot people touch, a strategic reserve for the next generation. But from April 2027, that changes, and while much of the focus has been on pensions becoming liable for inheritance tax, the bigger story is what this does to the rest of your estate.
The real issue lies in how this change interacts with the Residence Nil Rate Band, an allowance that many people either misunderstand or don’t fully appreciate.
Currently, individuals can pass on £325,000 tax-free, plus an additional £175,000 if they leave their home to direct descendants. For couples, this can amount to up to £1 million passing on without Inheritance Tax. However, this additional residence allowance comes with a critical condition, it begins to be withdrawn once an estate exceeds £2 million, reducing by £1 for every £2 above that threshold until it disappears entirely.
Until now, many families have structured their affairs in a way that keeps their taxable estate below that £2 million mark, often with significant wealth held inside pensions, safely outside the inheritance tax net. The inclusion of pensions from April 2027 changes that calculation overnight. What previously sat outside the estate will now be counted within it, meaning many more families will find themselves breaching the £2 million threshold without having changed anything at all.
This is where the trap is sprung.
It’s not just that pensions could now be taxed, it’s that their inclusion may push an estate into a position where the Residence Nil Rate Band is reduced or lost entirely. In effect, families are hit twice: once through the increased value of the estate and again through the removal of a valuable allowance. The result is often a significantly higher inheritance tax bill than expected, not because of a single change, but because of how multiple rules interact.
For some, the impact goes even further. Beneficiaries drawing on inherited pension funds may also face income tax, meaning what was once one of the most tax-efficient vehicles for passing on wealth could become far less attractive. It’s this layering of tax. Inheritance tax combined with potential income tax, that creates what many are now calling a “double” or even “triple” whammy.
The key point here is not to alarm, but to highlight how important proactive planning has become. Strategies that once made perfect sense, such as preserving pensions for later life or passing them on intact, may need to be revisited in light of these changes. The focus is shifting from simply building wealth to carefully structuring it, ensuring that allowances like the Residence Nil Rate Band are not unintentionally lost.
Ultimately, Inheritance Tax planning is no longer just about how much you have, but how everything fits together. And as the rules evolve, so too must the strategy, because in many cases, the biggest risk isn’t the tax itself, but falling into a trap you didn’t see coming.
If you would like to review your Inheritance Tax planning to see how the new rules might affect you then please get in touch.
