From 6 April 2027, most unused pension funds and death benefits will be included within the value of an individual’s estate for IHT purposes.

Historically, pensions have often been left undrawn where other assets could fund retirement because of the favourable treatment available on death. For some families, that has made the pension an important part of intergenerational wealth planning.

The new rules fundamentally change that calculation.

This does not mean everyone should start drawing their pension or changing existing arrangements now. The right approach will depend on individual circumstances, including the size of the pension fund and wider estate, income requirements, age, beneficiaries and other assets.

The existing rules also remain in place until April 2027. Making decisions purely in anticipation of the change, without considering the wider financial position, could have unintended consequences.

For business owners in particular, building wealth outside the business has always been an important part of long-term financial planning.

A significant proportion of an owner’s wealth can be tied up in the company or family business. When the time comes to step back, sell, gift shares or pass responsibility to the next generation, the income previously provided by salary or dividends may reduce substantially.

A pension can provide a source of retirement income that is independent of the business.

Pensions also continue to offer valuable tax advantages. Subject to individual circumstances, earnings and allowances, the standard annual allowance is currently £60,000, while unused annual allowance from the previous three tax years may sometimes be carried forward.

For some higher earners, pension contributions can also help manage adjusted net income. The personal allowance begins to reduce once income exceeds £100,000 and is lost entirely at £125,140. Pension contributions can, in the right circumstances, reduce adjusted net income and restore some or all of that allowance.

For example, someone earning £125,140 who is eligible to make the contribution could make a net pension contribution of £20,112, creating a gross contribution of £25,140. This could restore their personal allowance and result in effective tax relief of 60%.

There are limits and conditions governing pension contributions and tax relief, so individual advice is important before taking action.

For owner-managed businesses, it is also worth considering the role of employer pension contributions.

Many business owners make pension contributions through their company rather than personally. Employer contributions to a registered pension scheme can usually be deducted as a business expense where the relevant conditions are met, reducing taxable profits.

This means pensions should not be considered solely as a personal financial planning issue. Decisions around remuneration, profits, succession and retirement can all interact, which is why bringing together financial planning, accountancy and tax advice can be particularly valuable.

There is another change further ahead. From April 2029, only the first £2,000 of employee pension contributions made through salary sacrifice each year will remain exempt from National Insurance contributions. Contributions above that amount will remain exempt from Income Tax, subject to the usual limits, but employer and employee National Insurance will apply to the excess.

The forthcoming changes are particularly relevant for business owners already thinking about succession.

Changes to APR and BPR may encourage some families to consider passing business assets to the next generation earlier. If an owner transfers some or all of their interest in the business, however, they may also give up some of the salary, dividends or other income it previously provided.

That makes it important to consider two questions together: how will ownership of the business pass to the next generation, and how will the current owner fund the rest of their life?

For some, pension income may become a more important part of that answer.

Likewise, where an individual begins drawing income from a pension that they do not need for their own expenditure, gifting may form part of the wider estate-planning discussion. However, gifting has its own tax and financial implications and should be considered in the context of the individual’s overall circumstances rather than in isolation.

The tax position on death will depend on a number of factors, including the individual’s age, the beneficiary and the wider estate.

Under the new rules, where a pension falls within an estate that is subject to IHT, tax may first be payable on the pension as part of the estate. Where the pension holder dies aged 75 or over, beneficiaries may also pay Income Tax at their own marginal rate when subsequently drawing taxable inherited pension benefits.

The potential combined effect can therefore be significant.

For illustration, where IHT at 40% applies, and the remaining pension is subsequently subject to Income Tax, the effective tax position could look like this:

These figures illustrate the combined effect where the pension is subject to 40% IHT and the remaining taxable benefits are then drawn by the beneficiary. The actual tax treatment will depend on the circumstances of the estate and beneficiary.

For some people approaching or already in retirement, the changes may prompt a review of whether leaving pension benefits untouched remains the most appropriate strategy.

Most people can currently take up to 25% of their pension as a tax-free lump sum, subject to the standard lump sum allowance, which is currently £268,275. Some people have protections that allow a higher amount.

For someone who has reached retirement age but has not yet taken their tax-free cash, it may therefore be appropriate to review the position ahead of April 2027.

That does not mean taking the money will automatically be the right answer. Once withdrawn, the funds become part of the individual’s wider personal assets and may themselves be subject to IHT. There may also be investment, income and longer-term planning implications.

The important point is to review the decision rather than assume that the strategy which made sense under the old rules will remain appropriate after April 2027.

Pension nominations should also form part of the review.

Business owners and their families may have made nominations many years ago when the tax environment, family circumstances and intentions for their wealth looked very different.

In particular, people who are married or in a civil partnership and have nominated children, grandchildren or other beneficiaries may want to review those arrangements in light of the new rules. Transfers to a surviving spouse or civil partner can generally benefit from the IHT spouse exemption, while leaving pension benefits directly to other beneficiaries may produce a different tax outcome.

Again, tax should not be the only consideration. The appropriate nomination will depend on family circumstances and what the individual ultimately wants their pension to achieve.

Perhaps the biggest lesson from the 2027 changes is that pensions can no longer be considered separately from succession and estate planning.

For a business owner, decisions about the pension may interact with when they step back from the business, whether shares are sold or gifted, the income they will need in retirement, what other assets they own and what they ultimately want to pass to their family.

That requires a joined-up approach.

As part of Kinbrook Group, Old Mill brings together financial planning, tax and accountancy expertise, helping business owners and individuals manage their finances effectively. Where needed, wider specialist expertise can be accessed from across the Group, while clients continue to work with the advisers who understand their business, family and longer-term objectives.

The changes do not mean pensions have stopped being valuable. They do mean that some of the assumptions on which previous pension and estate planning decisions were based are changing.

With April 2027 approaching, now is the time to review your pension, succession plans and wider financial position and understand whether your existing arrangements remain right for you.

If you would like to discuss how the pension and inheritance tax changes could affect you, speak to Tim Blowers or contact your usual Old Mill adviser, backed by the wider expertise of Kinbrook Group.