From April next year, defined contribution pension schemes will once again form part of an individual’s estate for inheritance tax (IHT) purposes. This represents a significant shift in how pensions are treated and has important implications for long-term financial and estate planning. For many individuals, particularly those with substantial pension entitlements, this change may increase the potential inheritance tax exposure on their estate. As a result, it is more important than ever to understand the options available and take a proactive approach to planning. Historically, pension benefits have often been considered an efficient way to pass on wealth, as they could sit outside of an individual’s estate for inheritance tax purposes. However, with defined contribution pensions now being brought back into scope for IHT, their value may be included when calculating the overall estate on death. This could push some estates above the available tax-free thresholds, resulting in a higher tax liability for beneficiaries. Given that inheritance tax is typically charged at 40% on the value of an estate above the nil-rate band (and any applicable allowances), the potential impact should not be underestimated. Inheritance tax planning is most effective when it is approached early and reviewed regularly. Unlike some areas of tax planning, many of the strategies used to mitigate inheritance tax rely on time, particularly where lifetime gifting is concerned. Leaving planning too late can significantly limit the options available. With this in mind, individuals with defined contribution pensions should consider reviewing their wider estate position and exploring appropriate strategies well in advance. One option available to many pension holders is to take up to 25% of their pension as a tax-free lump sum. By doing so, individuals can: Remove a portion of the pension from the scheme Gain greater flexibility over how those funds are used or distributed Potentially begin implementing other estate planning strategies However, it is important to consider how these funds are managed once withdrawn. If retained within the estate, they may still be subject to inheritance tax. As such, this approach is often most effective when combined with further planning. Lifetime gifting remains one of the most widely used and effective ways to reduce inheritance tax exposure. By gifting assets to family members, individuals can reduce the value of their estate. However, there are important rules to be aware of. In most cases, gifts fall under what are known as “potentially exempt transfers.” This means that if you survive for seven years after making the gift, it becomes fully exempt from inheritance tax. However, if you pass away within seven years, the gift may still be subject to tax. In these circumstances, a sliding scale known as taper relief may apply, reducing the amount of tax payable depending on how many years have passed since the gift was made. This reinforces the importance of planning early, as the full benefit of gifting strategies is only realised over time. There are also specific gifting allowances that can be used each tax year without affecting the seven-year rule. These include: The annual exemption (currently £3,000 per individual) Small gifts allowance Gifts made out of surplus income, provided certain conditions are met While these allowances may appear modest, when used consistently over time they can contribute meaningfully to reducing the overall value of an estate. Another, often overlooked, aspect of inheritance tax planning is the simple use of capital during one’s lifetime. This may include: Supporting family members with education or property purchases Enhancing personal lifestyle or retirement plans Reallocating wealth in a way that aligns with personal priorities While this is not a tax strategy in the traditional sense, reducing the value of the estate naturally reduces the potential inheritance tax liability. The reintroduction of defined contribution pensions into the inheritance tax framework highlights the importance of taking a holistic view of your financial position. This may involve: Reviewing wills and estate planning arrangements Considering the use of trusts where appropriate Ensuring pension nominations are up to date Aligning pension planning with broader financial goals Each individual’s circumstances will differ and there is no one-size-fits-all approach. Tailored advice is essential to ensure that any strategy is both effective and appropriate. A common mistake is assuming that pensions will automatically remain outside the scope of inheritance tax or delaying planning until later in life. In reality, the earlier these matters are addressed, the greater the range of options available. It is also important to ensure that any actions taken, particularly around gifting, are properly documented and structured to comply with HMRC requirements. The inclusion of defined contribution pensions within inheritance tax calculations represents a meaningful change, but it also presents an opportunity to revisit and strengthen your estate planning strategy. By taking a proactive approach, you can: Reduce the potential tax burden on your beneficiaries Gain greater control over how your wealth is distributed Ensure your financial plans align with your long-term intentions At Richard Riley & Associates, we work with individuals and families to provide clear, practical guidance on inheritance tax and estate planning. We can help you understand how these changes affect your specific situation, identify appropriate strategies to minimise tax exposure and put a structured plan in place for the future If you would like to review your position or discuss your options in more detail, please do get in touch with our team. Early advice can make a significant difference to the outcome.Understanding the Change
Why Early Planning Is Essential
Taking a Tax-Free Lump Sum
Gifting to Family Members
Making Use of Annual Allowances
Spending and Lifestyle Planning
Reviewing Your Overall Estate Structure
Avoiding Common Pitfalls
Start Planning Now
