More concerns over UK Inheritance Tax

Butler said while there has been an incentive to not have a BDBN in the past in respect of UK pension benefits from an IHT perspective, this position should be reconsidered after 5 April 2027 as from 6 April 2027 both discretionary and non-discretionary pension benefits will be subject to IHT apart from where the spouse exemption applies.

He explained the UK IHT is a tax imposed on the transfer of wealth on death and, in some cases, certain lifetime transfers.

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“While Australia does not currently impose an equivalent estate tax, UK IHT remains highly relevant to Australians who retain connections with the UK, including dual citizens, former UK residents and individuals holding UK-origin pension benefits or other UK assets,” Butler said.

“Where an individual falls within the UK IHT regime, His Majesty’s Revenue and Customs (HMRC) generally imposes a 40 per cent tax on the value of assets exceeding the available nil-rate bands.”

According to Butler, previously it was expected that less than 10 per cent of estates annually were forecast to have IHT liabilities as a result of a “generous combination of nil-rate bands, exemptions and reliefs”.

“Notably, the IHT nil-rate band allows estates to pass on £325,000 to beneficiaries without incurring an IHT charge. There is an additional £175,000 residence nil-rate band available where a principal home passes to direct descendants,” he said.

“These nil-rate bands have been extended to operate until 5 April 2030. The thresholds have been frozen since 2009, providing for fiscal drag to increase the amount of estates exposed to IHT liability. Additionally, gifts made within the last seven years of life are brought back into the estate calculation for IHT purposes.”

He added that historically, exposure to UK IHT depended heavily on concepts of domicile and deemed domicile, however, from 6 April 2025, these concepts were reformed through the introduction of the long-term UK residence rules discussed further below.

“Historically, pension benefits have generally received favourable treatment for IHT purposes, subject to the structure of the fund’s death benefit arrangements. Where trustees or pension scheme administrators retained ultimate discretion regarding the payment of death benefits, these amounts were generally regarded as falling outside the member’s estate and therefore outside the scope of IHT,” he said.

“This issue has been relevant for Australian superannuation funds holding UK-sourced funds, based on HMRC’s published guidance in IHTM17052 where it states that where a member can direct who will receive a lump death benefit and the trustee is bound to follow that direction, the member may be regarded as having a ‘power to dispose’ of the relevant property.”

Butler said for individuals caught in the UK IHT net, executing a BDBN in respect of UK-sourced pension or superannuation assets may result in those benefits forming part of the member’s estate for IHT purposes, but this position is likely to change from 6 April 2027.

“For this reason, some advisers recommended removing BDBN and like clauses from SMSF deeds altogether to protect the fund’s discretionary status. This reflected a concern, based on existing HMRC guidance, that the mere existence of a power enabling a member to bind the trustee, gave rise to risk of IHT,” he said.

“From 6 April 2027, the distinction between discretionary and non-discretionary arrangements will be removed and most pension benefits will be brought within the value of a deceased person’s estate for IHT purposes, regardless of whether trustee discretion previously existed.”

Furthermore, Butler said, HMRC has confirmed that while these amounts will generally be included in the deceased member’s estate, transfers to a surviving spouse may continue to access the spouse exemption.

“However, pension benefits passing to children or other non-spouse beneficiaries may increase the estate’s exposure to IHT, therefore, since pension benefits will be within the IHT net from 6 April 2027, it is worthwhile considering whether a BDBN should be implemented after 5 April 2027,” he said.

“From 6 April 2027, having a BDBN so that pension benefits are paid to a surviving spouse should assist in obtaining the spouse exemption from IHT.”

He said individuals who fall within the long-term UK resident regime may be exposed to IHT on their worldwide assets, including interests in non-UK structures such as Australian superannuation funds and family trusts.

“The long-term UK residence rules introduced on 6 April 2025 replaced the previous regime based primarily on domicile and deemed domicile concepts, so if an individual is classified as a long-term UK resident, their non-UK assets may also be subject to IHT when they die or make certain transfers of wealth,” he explained.

“An individual will be a long-term UK resident in a tax year if they are a tax resident in the UK for either the previous 10 consecutive years or a total of 10 years or more within the previous 20 years.”

In regard to Qualifying Recognised Overseas Pension Scheme transfers to SMSFs, Butler said that under the current UK tax framework, transfers from a UK pension fund to an Australian SMSF that satisfies the relevant criteria can be recognised as a QROPS.

“QROPs can be made without UK transfer taxes, subject to the same-jurisdiction requirements and the member’s available Overseas Transfer Allowance and transfers in excess of the member’s available OTA may be subject to a 25 per cent tax charge on the excess amount,” he said.

“Historically, transferring UK pension benefits to an Australian SMSF has often formed part of broader succession and estate planning strategies. 

“While a transfer to an Australian SMSF may continue to provide a range of superannuation, tax and estate planning benefits, the introduction of the new IHT rules means that individuals who remain within the UK IHT net (including under the long-term UK residence rules) will also need to consider the potential IHT implications of assets held through an Australian SMSF from 6 April 2027.”

He said the average IHT liability is expected to increase by around £34,000 when pension benefits are included in the value of the estate and the deceased person’s legal personal representatives are liable for reporting and paying any IHT.