Protect Your UK Pension: Navigating the New (40%) Inheritance Tax in Australia
Inheritance tax (IHT) and UK Pensions is not something that we have been accustomed to. Unfortunately, in a significant shift in Autumn 2024, the UK Government announced that UK Pensions will be included in the Inheritance tax (IHT) regime starting from April 2027.
This shift has been a trigger for many UK expats in Australia to consider their options with their UK Pensions. The following provides an introduction on how to navigate the change in the tax regime.
Current Inheritance Tax Rules
Let’s first revisit the existing rules, inheritance tax is levied on the value of an estate that exceeds a certain threshold. The standard IHT threshold is £325,000, with an additional residence nil-rate band of £175,000 if the estate includes a home left to direct descendants, bringing the total to £500,000.
Under the current rules if your estate exceeds this threshold, the amount above £325,000 is taxed at 40%. It is, of course, worth noting that there are several exemptions, such as the annual exemption, small gift exemption, business relief and agricultural relief and gifts to spouses and charities.
Currently, pensions are not included in the calculation of the estate's value for IHT purposes. Instead, they are subject to a different tax regime. If the pension holder dies before the age of 75, the beneficiaries can inherit the pension tax-free. If the pension holder dies at 75 or older, the beneficiaries pay income tax on the inherited pension at their personal tax rate.
Changes from April 2027
From April 2027, the value of unspent pension funds will be included in the estate for IHT purposes. This means that pensions will be added to the total value of the estate, potentially pushing it above the IHT threshold and subjecting it to the 40% tax rate.
The inclusion of pensions in the IHT regime will have several implications:
Increased Tax Liability: Many estates that previously fell below the IHT threshold may now exceed it due to the inclusion of pension funds. Unfortunately, this could result in a significant tax liability and particularly for Australian’s holding UK Pensions expose them to a tax regime for the first time.
Estate Planning: The importance of revisiting estate planning instructions to instigate change to avoid the new tax is vital. For example, it may now be an appropriate time to transfer your UK Pensions to a suitable Australian account to provide a better estate planning outcome.
Impact on Retirement Planning: The change may also influence how people approach their retirement savings. Some UK Pension holders may now re-consider the order in which they spend their retirement savings or for UK Pension holders in Australia, bring forward plans to transfer their accounts to Australia.
UK Pension holders in Australia
As noted above, for the first time Australian UK Pension holders may find themselves exposed to an Inheritance tax from April 2027, potentially as high as 40%. This provides an opportunity to re-consider your plans for your UK Pension. For example, we are seeing early evidence of increased demand to bring UK Pensions into the Australian superannuation environment as a means to avoid UK Inheritance tax. This is often a complex process however here is an overview on the steps typically required to complete:
Check whether your UK Pension can be transferred to Australia, typically, state pensions and unfunded public sector pensions cannot be transferred.
Determine whether you would like to transfer to a Qualifying Recognised Overseas Pension Scheme (QROPS) in Australia. This ensures that the transfer is compliant with both UK and Australian regulations.
You will need to determine compatibility between your UK Pension and the chosen option in Australia. Not all Australian funds have QROPS status and when choosing a SIPP this means your UK Pensions, whilst held in Australia, do not immediately consolidate with your Australian superannuation assets.
As discussed above, when transferring your UK Pension to Australia, it can avoid Inheritance tax in the UK, however caution needs to be taken to ensure that you do not face Australian tax. For example, tax may be payable if your transfer exceeds the UK’s lifetime allowance or if your transferred amount exceeds the Australian non-concessional contributions cap.
You may be thinking after reading the above that the transfer process is too hard, well there is some silver lining and hence worth persisting. Firstly, not only can you avoid the UK Inheritance tax regime, secondly, Australian superannuation funds are tax free over the age of 60.
It is also worthing noting the friendly currency conversion from UK Pounds into Australian dollars.
Outcome
Our experience shows that consolidating UK Pensions into the Australian superannuation framework can provide a terrific long-term outcome, however more so, it provides an opportunity to include what is often a significant amount of money into your overall investment plan. As professional advisers, we feel aligning each pool of your retirement savings with your long-term goals, dreams and aspirations provides a superior long-term outcome and this regulatory change may be the catalyst to review your UK Pensions.
General Advice Warning
The information in this article is general advice only. It does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation and needs. You should seek independent financial advice to discuss your personal circumstances.