With news today that the IHT take seems to be rising inexorably, Andy Zanelli, head of technical engagement at Aberdeen Adviser looks in this case study article for Financial Planning Today at the worrying potential cost of IHT to future generations and why advisers need to start planning now to avoid a nasty tax trap.

What follows is a fictitious sample case study I have constructed to illustrate the possible IHT tax risks facing many older people who have saved and invested diligently throughout their lives.

It started with what seemed like a fortunate choice at the time. At the height of the defined benefit (DB) to defined contribution (DC) transfer era, many employees were offered cash equivalent transfer values (CETVs) that looked too good to ignore.

Steven, who had a decent service and a solid salary, decided to take the leap. The transfer value on offer to him was £900,000.

Fast forward to today and that DC pension pot has grown to £1.2 million. Add to that £500,000 in property and £500,000 in investments, and Steven and his wife, Susan, now sit on assets of £2.2 million. On paper, their future looks secure.

There is more good news. Steven still works for the same employer, who continues to provide a generous death-in-service (DIS) benefit. At eight times salary, that’s another £500,000 of cover based on his £62,500 annual income. So far, so fortunate.

The picture before April 2027

Under today’s rules, things look remarkably straightforward. Should one partner die before 6 April 2027, the estate can be left to the surviving spouse free of inheritance tax (IHT) thanks to the inter-spouse exemption. Steven’s DC pension would also sit outside the estate. His DIS lump sum, triggered on first death, would be paid directly to the surviving spouse and also escape IHT under current legislation.

In other words, before 6 April 2027, there would be no inheritance tax at all on first death.

How things change after reform

After 6 April 2027, the landscape shifts. Should Steven die first, mirror wills and the inter-spouse exemption will continue to protect the estate, while the pension benefits can still flow to Susan. If Steven was to die while still employed, the DIS lump sum would also be received by Susan, just as before.

The challenge comes on Susan’s death. At that point, the inherited DIS proceeds will have crystallised as part of her estate. Combined with the £1.2 million pension fund and £1,000,000 in other assets, that pushes her taxable estate to £2.7 million, with £1.7 million of it exposed to IHT at 40 per cent. That alone creates a potential liability of £680,000.

The taper trap

Before looking at how it applies here, it’s worth recalling what taper relief means. Under current inheritance tax rules, the residence nil-rate band (RNRB) begins to reduce once an estate exceeds £2 million. The allowance is withdrawn by £1 for every £2 of value above that level and disappears completely at £2.35 million for a single person, or around £2.7 million for a couple making full use of both RNRBs. In practice, this means that larger joint estates can lose these valuable allowances altogether, increasing the eventual IHT bill.

So, there is another sting in the tail here. Susan’s estate could be valued at £2.7 million – well above the threshold at which the residence nil-rate band (RNRB) begins to taper away. She would lose this allowance altogether, costing another £140,000 in IHT.

What once looked like a carefully built financial safety net could now create an £820,000 tax problem for the next generation.

What advisers should be doing now

For advisers, the lesson is clear. “Lucky” DB transfer millionaires may not feel so lucky when new IHT rules bite. Without planning, what appears to be a strong position today could turn into a substantial tax drag tomorrow.

Key actions include:

• Reassessing estate plans with pensions fully in view.
• Ensuring clients and their executors understand the shift in responsibilities under the new rules.
• Exploring liquidity options to cover future IHT liabilities without forcing distressed asset sales.
• Reviewing beneficiary nominations to balance tax efficiency with fairness.

A wake-up call

For many clients, pensions have been treated as a safe, IHT-free inheritance. From April 2027, that assumption will no longer hold. The “lucky” DB transfer millionaires may find themselves less fortunate when the next generation comes to inherit.

For advisers, this change represents both a challenge and an opportunity – to help clients rethink their strategies before the taxman takes a much larger slice than anyone expected.

Andy Zanelli is head of technical engagement at Aberdeen Adviser. Mr Zanelli has over 30 years’ experience in financial services. At Aberdeen, he leads a team of highly experienced technical consultants who work with advisers across tax, trust, retirement and estate planning. His focus is on identifying and communicating change and the opportunities this presents for advisers and their clients.

https://www.aberdeenadviser.com/en-gb