New UK inheritance tax rules for SIPPs: what you need to know

The recent Labour budget has introduced a significant change to UK inheritance tax (IHT) rules, extending liability to Self-Invested Personal Pensions (SIPPs). Previously, pensions held within SIPPs were considered outside of an individual’s estate for IHT purposes, providing a valuable estate-planning tool. This shift represents a fundamental change in pension planning and estate management for many people.

Here, we’ll outline the new rules, their implications, and how cash flow modelling and financial planning can help you navigate this new landscape.

What Are the New Rules?

Under the new legislation, funds held within a SIPP will now be subject to inheritance tax if passed to beneficiaries upon the death of the pension holder. Key aspects include:

1. Taxable Estate Inclusion: The value of the SIPP at the date of death will be included in the deceased’s taxable estate, potentially incurring a 40% tax on amounts above the nil-rate band (£325,000 or £500,000 with the residence nil-rate band).

2. Application to Defined Contribution Scheme: This change affects defined contribution pensions in SIPPs. Defined benefit pensions, which are less flexible for inheritance purposes, remain unaffected.

3. Impact on Death Before 75: Previously, SIPP funds passed tax-free if the pension holder died before age 75. Under the new rules, even in these cases, SIPP assets will face IHT.

4. Death After 75: For individuals dying after 75, beneficiaries will face both IHT on the SIPP and income tax at their marginal rate when withdrawing funds.

Who Is Most Affected?

• Individuals with large pension pots who had planned to pass SIPP funds to heirs tax-free.

• High-net-worth individuals who relied on pensions as a tax-efficient way to mitigate IHT.

• People nearing retirement who may need to reassess their financial plans to avoid unintended tax liabilities.

How Financial Planning Can Help

The big question is what should you do in the light of the changes. The new rules demand careful planning to ensure your pensions are managed effectively within your broader estate strategy. Here are some thoughts on things you might consider:

1. Assessing Your Lifetime Needs: Cash flow modelling allows you to project your future income, expenditure, and savings, helping you determine how much of your SIPP funds you’ll need for retirement. By spending or gifting excess funds, you can reduce the size of your taxable estate.

2. Exploring Pension Drawdown Options: Strategic drawdowns from your SIPP during your lifetime could reduce the pot size subject to IHT while providing income flexibility. Modelling different withdrawal scenarios can help optimise your approach.

3. Diversifying Wealth: Consider redirecting contributions or transfers to other investment vehicles, which remain outside the scope of IHT. Financial planners can guide you on tax-efficient investments to preserve wealth for your beneficiaries.

4. Gifting and Trusts: Using your annual gift allowance or establishing trusts can help reduce your estate’s taxable value. Cash flow modelling can ensure that gifting doesn’t jeopardise your retirement security.

5. Reviewing Beneficiary Nominations: While SIPP beneficiaries will now face IHT, it remains crucial to regularly update beneficiary nominations. Strategic designations can help mitigate tax liabilities or ensure the funds are passed to those with lower overall tax burdens.

What Should You Do Next?

• Review Your Pension and Estate Plans - Work with a financial adviser to understand how the new rules impact your existing plans.

• Consider Early Action - By restructuring your wealth now, you may reduce future IHT liabilities.

• Leverage Cash Flow Modelling - A comprehensive cash flow plan can provide clarity on your financial future and help make informed decisions.

• Stay Informed - Monitor further developments, as changes to tax policy may continue under the current government.

Conclusion

The inclusion of SIPPs in the scope of inheritance tax represents a substantial shift in how pensions are treated in estate planning. However, with the right financial advice and tools like cash flow modelling, you can adapt your strategy to minimise tax liabilities while securing your financial future.

For those with larger estates, the tax implications can be even more severe. If the total value of an individual’s estate exceeds £2 million, the Residence Nil Rate Band (RNRB)—an additional allowance of up to £175,000 per person—is gradually tapered down by £1 for every £2 above this threshold. When combined with the 40% inheritance tax on SIPP assets and the income tax beneficiaries may face when withdrawing funds from inherited pensions, some estates can experience an effective tax rate of over 80%. This underscores the critical importance of proactive financial planning to mitigate the disproportionate erosion of wealth.

If you’re unsure how to proceed, please get in touch to start building a plan that reflects the new tax landscape. It’s never too early to take control of your financial legacy.

Contact us to make dealing with IHT on your SIPP part of your financial plan

If a future IHT bill for your children or grandchildren is a priority for you, making it part of your wider financial plan could help put your mind at ease. We could help you assess how the increase in tax could affect you and adjust your plan if necessary. Please get in touch to arrange a meeting.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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