10 Common Misunderstandings About Pensions and Inheritance Tax
Inheritance tax (IHT) and pensions are often misunderstood, and with upcoming rule changes, including pensions being included in estates from 6th April 2027, it’s more important than ever to get the facts straight. Misconceptions can lead to planning errors, unexpected tax bills, or missed opportunities to protect your wealth.
Here are some of the most common myths explained:
1. ‘Only the wealthy pay inheritance tax’
Many people assume that IHT only affects the super-rich. In reality, frozen thresholds and rising asset values, particularly in property, mean more estates are likely to exceed the £325,000 nil-rate band. If you own a home or have savings and investments, it’s worth checking whether your estate could be liable.
2. ‘Gifting assets automatically reduces inheritance tax’
Gifts are not automatically exempt. Most gifts are Potentially Exempt Transfers (PETs). They are only fully exempt if you survive for seven years after making the gift.
Taper relief only reduces the tax due on any portion of the gift that exceeds the nil-rate band, not the entire gift. If you die within seven years, the value of these ‘failed gifts’ is added back into your estate and counts first against your £325,000 allowance.
3. ‘My spouse automatically inherits everything’
Dying without a Will means your estate is distributed according to intestacy rules, which may not pass everything to your spouse. This can create an IHT liability on the first death.
Transfers between legally married spouses or civil partners are generally exempt from IHT, but ensuring your estate is structured correctly is crucial to make the most of this exemption.
4. ‘Giving my house away removes it from my estate’
If you gift your home but continue to live in it without paying market-rate rent, it’s treated as a gift with reservation of benefit. This means it remains part of your estate for IHT purposes.
5. ‘Inheritance taxis paid automatically’
Inheritance tax is the executor’s responsibility, usually payable before probate is granted. This can create cash flow issues if most of your estate is tied up in property or illiquid assets.
6. ‘Assets held abroad aren’t subject to UK inheritance tax’
If you are UK-domiciled, your worldwide assets are potentially liable for IHT, though tax credits may be available for taxes paid abroad.
7. ‘You can pass on £1 million inheritance tax-free’
While married couples or civil partners can potentially pass on up to £1 million tax-free by combining the standard nil-rate band and the residence nil-rate band, this is not automatic band.
The residence nil-rate band tapers for estates over £2 million, and planning is required to make full use of both allowances.
8. ‘Pensions are forever exempt from inheritance tax’
Currently, most defined contribution pensions sit outside your taxable estate. However, from 6th April 2027, unused pension funds and death benefits will generally be included in your estate for IHT purposes.
Even modest pension pots can push estates over the thresholds when combined with property, savings, and investments. Planning now can help manage this exposure.
9. ‘My pension dies with me’ / ‘My Will controls who gets my pension’
Many pension schemes are written under a trust and are separate from your main estate for IHT purposes. This means you may be able to pass pensions on to your beneficiaries.
Importantly, who receives your pension is determined by your pension nomination or expression of wishes, not your Will. Ensuring this is up to date is critical to avoid unintended outcomes.
10. Business Property Relief (BPR) and AIM investments
BPR can reduce the IHT liability on qualifying business assets and AIM shares, but reliefs are not guaranteed. Conditions include holding periods of at least two years and qualifying business structures.
Why understanding the truth matters
Misconceptions about IHT and pensions are widespread, and with major rule changes on the horizon, relying on outdated assumptions could be costly. Even those who have never worried about IHT may now find themselves exposed, especially in areas with higher property values.
Taking the time to evaluate your financial situation with an independent financial adviser will enable you to:
Understand your total estate, including pensions, property, and investments
Review gifts and charitable donations
Align your Will, pension nominations, and reliefs
Explore legitimate planning strategies to reduce potential IHT liability
Next Steps
Inheritance tax and pensions can be complex, but dispelling common myths and taking a structured approach gives you clarity and control. Early action is key to maximising allowances, reliefs, and flexibility, helping you protect your wealth and pass it on according to your wishes.
At Harold Stephens, we help families in Bristol and beyond review their inheritance tax and pension planning. Call us on 0117 3636 212 or email office@haroldstephens.co.uk to book on to one of our free financial planning seminars in March or arrange a relaxed call about your circumstances.