Question: I am a teacher. I have read about the government putting inheritance tax (IHT) on pensions and am now worried about how it will affect me and my family when my pension is passed to my wife. Can you let me know what the implications are for me and others in my situation?
Answer: There has been a lot of coverage about the rules on pensions and IHT changing from April 2027. But it’s worth noting that the changes won’t affect everyone in the same way.
Those who work in the public sector usually have defined benefit (DB) pensions, where the pension they receive depends on how long they have worked and what their salary was. Although they are only slightly affected by the changes, it’s worth understanding what benefits are paid on death and where IHT may apply.
Let’s start with where IHT doesn’t apply. If the pension holder dies, part of their pension will usually continue to be paid to their spouse, civil partner or partner at a reduced rate. The person receiving it will normally pay income tax on these payments, but these payments would not count as part of the estate for IHT.
If the pension your beneficiary would receive is very small, the scheme may offer a one-off cash payment instead. If that happens, this lump sum would sit outside your estate and would not count when working out IHT.
Some pension schemes offer “death-in-service” lump sums, where a lump sum payment is made on an employee’s death before they have taken a pension, and usually worked out as a multiple of salary – for example, four times salary. Again, this is another exempt payment and is not considered for IHT.
Turning now to what is counted. Public sector pensions are usually guaranteed to be paid for five years, even if the member dies in that period. If that happens, then the value of the remaining instalments would be counted in the estate for IHT. The scheme administrator would be responsible for working out how much that lump sum would be.
And the new rules may have implications for those people who have built up additional voluntary contributions (AVCs) under their pension scheme. Usually, AVCs can be used to buy additional amounts of pension or additional years of service. But sometimes – for example, under the teachers’ pension scheme – the AVC is a defined contribution pension, where money is built up in a pension pot and its value depends on contributions and investment growth.
Those people who have built up a defined contribution AVC and either have not yet started taking money from their pension or who have taken a tax-free lump sum and moved the rest into drawdown to provide an income (if that option is available) will have to include the value of the unused pension in their estate when working out what, if any, IHT is due.
A final practical point: the person dealing with your estate will be responsible for sorting out any IHT and making sure it is paid. In some cases, they may be able to ask the pension scheme to pay the tax directly, which could make things simpler.
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