UK pension tax changes: what impact on residents of France

Most unused funds held in UK pension schemes will come within the scope of UK inheritance tax from April 6, 2027, removing an inheritance-planning advantage that many people have relied on in recent years.

This does not necessarily mean that heirs will have UK inheritance tax to pay. Whether tax is ultimately due will depend on individual circumstances, including the value and make-up of the estate, who inherits, and the exemptions and reliefs available.

For people living in France, the position may also be affected by the interaction between new UK long-term residence rules and the longstanding UK-France inheritance tax treaty.

As these rules can be complex, people with significant UK pension funds may wish to take specialist advice on how the changes could affect their own succession planning.

Which pensions are affected?

The most common kind of UK pension affected is a defined contribution pension. These are often not converted into an annuity but instead used as a ‘pot’ from which the holder can draw from time to time, potentially leaving the remainder to their heirs.

The Connexion discussed the issue with financial advisers David Morley, head of wealth structuring at Blevins Franks, and Robert Kent of Kentingtons.

Mr Morley said that decades ago defined contribution pensions were mostly associated with self-employed people and some company directors. However, from the late 1980s and early 1990s, more companies began using them for employees as they moved away from final salary pension schemes.

Options for pension holders

Regarding options for people who had been planning to leave pension money to their heirs, he said: “Your choices include accepting the situation, maybe starting to draw down the pension at an accelerated rate, perhaps gifting those people money from somewhere else.

“They could also look at extracting the pension from the UK – so, explore the moving of that pension or the potential of taking all the money as one big lump sum, which has favourable tax rates in France [a special 7.5% income tax rate on qualifying pension lump sums] compared to leaving it in the UK.

“But they would need to make sure that any action is suitable for their own situation, so I wouldn’t do it without taking specialist advice.”

This is because people have to consider not only UK tax liabilities but also potential French tax liabilities, including gift tax in the case of lifetime gifts.

He added: “What people also need to be aware of is, although there is UK inheritance tax, they can use the UK exemptions and potentially nil-rate bands to lower those taxes. So, they may not have to lose the money in any way, shape or form.

“Anyone with a defined contribution pension should be aware of the new rules, but whether or not there would be actual inheritance tax is a matter of individual circumstances.”

Mr Morley said the new rules can also apply in some cases to pensions that provide an income continuing after the holder’s death. The value of such benefits may need to be established for inheritance tax purposes.

However, in many cases where the beneficiary is a spouse or civil partner there will be no tax because of the spouse exemption.

How the rules change from April 2027

Mr Kent said that in recent years many people have deliberately drawn on other investments first and preserved their pension because the remaining fund could usually pass to beneficiaries outside the estate for UK inheritance tax purposes.

“That position changes for deaths from 6 April 2027, when most unused pension funds and pension death benefits will be included in the estate for UK inheritance tax. The provisions are wider than just defined contribution pots, although these are where the change will have the greatest practical impact.

“Certain benefits remain excluded, including qualifying dependants’ pensions and death-in-service benefits, and transfers to a spouse or civil partner can still be exempt.

“However, the change reverses a financial-planning strategy that has been widely used for years.

“Many retirees have spent their other capital first and preserved their pension as the last asset to draw upon, partly because it could be passed efficiently to their family. From April 2027, that advantage will be significantly reduced.”

Should you withdraw your pension?

He said, however, that it does not follow that everyone in France should cash in their UK pension before next April.

“A pension withdrawal is generally taxable in France, and taking a large single sum can produce a substantial income-tax charge.”

In this regard, he said the new contribution différentielle sur les hauts revenus (CDHR) has created complications for larger withdrawals because it seeks to impose a minimum effective tax burden on households whose adjusted income exceeds the relevant thresholds.

The existing contribution exceptionnelle sur les hauts revenus (additional income tax on high incomes) may also need to be considered, he said.

“For that reason, the practical answer is usually to review the order and timing of withdrawals.

“Some people may now decide to run down their pension more quickly and preserve other assets instead, but the figures need to be modelled carefully.

“Taking several years’ income at once merely to avoid a possible future inheritance-tax charge can result in a large and immediate French tax bill.

“The review should consider the likely size of the estate, intended beneficiaries, spouse exemption, the member’s age and health, French taxation of withdrawals, whether the money will be spent, gifted or reinvested, and the French succession treatment of whatever replaces the pension. Beneficiary nominations should also be checked.

“The pension should no longer automatically be treated as the last asset to spend, but neither should it automatically be emptied. The right strategy is to compare the inheritance-tax exposure with the French tax cost of withdrawing the money during life.”