Case study: The significant impact of advice on Inheritance Tax planning

From April 2027, most unused pension funds and pension death benefits will be included within a person’s estate for inheritance tax purposes.  

That means pensions, which have often been treated as an efficient way to pass wealth on, may need to be reconsidered as part of a wider estate planning strategy. 

By 2030, one in 10 families are predicted to be subject to inheritance tax as a result of increasing property values, investments and pension savings pushing the overall estate above key thresholds.  

The good news is that, with expert advice on Inheritance Tax planning from a financial planner, you can potentially cut down your IHT bill. 

The following real-life example of an Attivo client (whose name has been changed) provides a great example of how advice can help reduce that liability while still supporting the client’s own income needs. Be mindful however that this illustrative example of a potential outcome, and should not be relied on as a guide to future returns. Actual outcomes will depend on your individual circumstances, market conditions, charges, fees and tax treatment. 

Introducing Margaret

Margaret is 68 and recently widowed. She has two children and two grandchildren, and her priority is clear: once her own needs are met, she wants as much of her estate as possible to pass to her family. 

The below table shows a summary of Margaret’s overall estate: 

 

At first glance, Margaret’s estate sits below the £2 million threshold at which the residence nil-rate band (NRB) begins to taper. But from April 2027, once her pension is included, her total estate value rises to £2.2 million. 

That creates two issues: the pension itself becomes exposed to inheritance tax, and part of her residence nil-rate band may be lost. The table below shows the difference this would make before and after April 2027: 

The financial planning approach

Step 1: Reviewing Margarets Will and LPAs 

The first step was to review Margaret’s will and lasting powers of attorney following her husband’s death. These are important foundations of estate planning because they help ensure her wishes can be carried out if she passes away or loses capacity. 

Step 2: Optimising on a discounted gift trust 

Margaret placed £500,000 into a discounted gift trust. This type of trust allows someone to make a gift while retaining the right to a predetermined income for life. In Margaret’s case, the trust was designed to provide £1,500 a month. 

The trust produced an immediate discount of £180,500, reducing the value of Margaret’s estate straight away and creating an immediate inheritance tax saving of £72,200. The remaining value of the gift is expected to fall outside her estate after seven years, provided the relevant conditions are met. 

It was also important that Margaret spent the income she received from the trust. If the income simply built back up in her own estate, it could reduce the effectiveness of the planning. 

Step 3: Contributing to a loan trust 

To provide additional flexibility, Margaret also settled £200,000 into a loan trust. This did not immediately remove the loaned money from her estate, but any investment growth within the trust would sit outside her estate. She could also recall the loan if needed, either as a lump sum or as regular payments. In this example, she used it to provide a further £500 a month. 

Step 4: Setting up a whole-of-life insurance policy 

Finally, because Margaret did not want to gift away any more capital at this stage, a whole of life insurance policy was arranged and written into trust for her children. The policy was set up for £280,000 and funded through withdrawals from her pension. As the policy was written into trust, the proceeds were intended to provide money outside her estate for her family, which could be used towards the IHT liability. 

The impact of advice on inheritance tax planning 

Before the April 2027 pension changes, Margaret’s net estate after inheritance tax was estimated at £1.84 million. After pensions become part of the estate, that figure would fall to £1.68 million, due to the additional inheritance tax liability. 

As illustrated in the below table, following a financial planner’s advice on Inheritance Tax planning, Margaret’s estimated inheritance tax liability after seven years was reduced from £520,000 to £280,000. More importantly, the combination of trusts and the whole of life policy increased the value expected to pass to her children and grandchildren from £1.68 million to around £2.2 million. 

Please note: The figures in this table do not consider any growth or payments made – for example, a discounted gift trust (DGT) of £1,500 per month, or pension withdrawals to pay protection premiums, which will affect the resulting value to beneficiaries. 

This did not remove Margaret’s inheritance tax liability entirely. Instead, the planning helped reduce the liability, control future growth within her estate, meet her income needs and create additional funds for her beneficiaries outside the estate. 

Why regular reviews matter 

Margaret’s plan may continue to evolve. If her circumstances change, she may decide she no longer needs access to the money in the loan trust and choose to gift it instead, starting the seven-year clock. Alternatively, she may later decide to reduce investment risk in her pension by purchasing an annuity, which could provide a guaranteed lifetime income and remove the pension fund from her estate. 

The right route will depend on personal circumstances, objectives, health, family needs and future legislation. That is why IHT planning should not be treated as a one-off exercise. It needs to be reviewed regularly, especially when rules change or life events occur. 

Key takeaways 

• From April 2027, unused pensions may increase the value of an estate for inheritance tax purposes. 

• Including pensions in the estate can also affect the residence nil-rate band where total estate value exceeds £2 million. 

• Trusts can help control how wealth is passed on, but they need careful advice and ongoing review. 

• Whole of life cover written into trust can provide funds outside the estate to help beneficiaries. 

• The earlier planning starts, the more options are likely to be available.