UK Government Confirms Major Inheritance Tax Reforms Affecting Expat Pensions
The United Kingdom government has announced significant reforms to its Inheritance Tax (IHT) system, with major implications for British expatriates residing in Portugal. The new policy, scheduled to take full effect from April 2027, will incorporate the value of unused pension funds into a person's estate for IHT calculation purposes, effectively ending a long-standing tax advantage. This legislative change is part of a broader overhaul that also sees the UK shift from a domicile-based IHT system to one determined by residency, a change that commenced on April 6, 2025.
Under the previous framework, UK-based pensions were generally considered outside of an individual's estate and could be passed to beneficiaries without incurring the standard 40% inheritance tax. This made them a highly efficient vehicle for intergenerational wealth transfer. The upcoming changes will eliminate this exemption. From April 2027, benefits from unused pension funds, whether taken as lump sums or through drawdown accounts, will be subject to IHT when passed to beneficiaries other than a spouse. The spousal exemption, which allows assets to transfer to a surviving spouse tax-free, will remain in place.
The responsibility for settling the IHT liability will fall to either the legal personal representatives of the deceased's estate or directly to the beneficiaries. Proposed legislation indicates that beneficiaries can request the pension scheme administrator to pay the tax from the fund itself. However, this creates a further complication: if the deceased was over 75, the withdrawal to pay the tax would itself be subject to income tax at the beneficiary's marginal rate. This could lead to a situation where the effective tax rate on the inherited pension funds is substantially higher than the 40% IHT rate.
This policy shift is occurring alongside the move to a residence-based IHT system. The new rules state that an individual's worldwide assets will be subject to UK IHT if they are a UK resident or have been a resident within a specific preceding period. For long-term non-residents, such as many British retirees in Portugal, their non-UK assets may fall outside the IHT net after a 10-year period of non-residence. However, the UK government has clarified that UK-sited assets will always remain within the scope of IHT. As UK pension schemes are considered UK-sited assets, they will be liable for IHT regardless of the owner's residence status.
This is a critical detail for British citizens in Portugal. Portugal's own inheritance law, which applies a limited 10% stamp duty ('Imposto do Selo') only on certain assets and exempts transfers to direct family members, does not override the UK's claim on UK-based assets. Financial experts from firms like Blacktower Financial Management have noted that many expatriates may have structured their financial affairs on the assumption that their pensions were protected from IHT. The government's confirmation of the new rules necessitates a widespread review of estate planning among the British expat community to assess and mitigate potential tax liabilities before the 2027 implementation date.
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