Families face inheritance tax raid on pensions – what it means on your wealth

Inheritance tax:  Pensions will be included in the assets that count towards death duties from April 2027

Chancellor Rachel Reeves has launched an inheritance tax raid on savers in the Budget by making pensions liable for the levy.

Pensions will be included in the assets that count towards 40 per cent inheritance tax from April 2027, throwing family legacy plans into turmoil.

What pulling pensions into inheritance tax means 

Adding unspent pension pots into inheritance tax calculations means thresholds will be breached by many more estates in future. 

The move is part of a £2billion raid on inheritance tax, which includes freezing the current main tax-free thresholds until 2030 and reforms to agricultural and business property reliefs.

Wealthier families breathed a sigh of relief as the main inheritance tax nil rate band will remain at £325,000, while the residence allowance of £175,000 for homes passed on to direct descendants will also be kept. This means married couples can still pass on up to £1million inheritance tax-free.

But the Chancellor revealed she would stage an inheritance tax raid on unused pension pots. 

Adding pension pots to inheritance tax calculations could also mean more are pulled into losing some of their residence nil rate band, which is gradually removed on estates worth more than £2million.

The Government said it was ‘removing the opportunity for individuals to use pensions as a vehicle for inheritance tax planning’ by bringing unspent pots into the scope of inheritance tax.

It expects this to affect around 8 per cent of estates each year, and raise £640million in 2027/28, £1.34billion the following year, and £1.46billion by the third year the new rules are in place.

How pensions could beat inheritance tax

Retirement savings were previously treated more generously by the taxman, especially if people died before the age 75.

They have therefore become widely used in inheritance tax planning, and advisers often recommend for wealthier families spend pension pots last if at all.

Pension and tax experts predict a crackdown will lead to a rise in gifting, and perhaps greater use of trusts and insurance products.

Beneficiaries of most defined contribution pension pots pay no tax at present if the owner dies before age 75 – though there are tricky rules to be aware of especially on larger funds.

They have to pay their normal income tax rate on withdrawals if the holder dies aged 75 or over. This means that rates on taking money out of pensions in this instance could be 20 per cent, 40 per cent or 45 per cent.

In the case of annuities, the capital is usually lost anyway after the death of you and your spouse, although there are exceptions.

Final salary pensions also usually end after the death of the holder or their surviving spouse. Read about the current rules on inherited pensions here.

Inheritance tax planning will change, say experts

‘Pensions have been seen as useful tool for estate planning and there will be individuals and families who have approached retirement and estate planning based on existing rules,’ says Mike Ambery, retirement savings director at Standard Life. 

‘Now, the value of pension pots will be added to the total value of other assets and if over the inheritance threshold of £325,000, aside from other exemptions, will be taxed in the same way. 

‘This represents a fundamental shift to how wealthier individuals think about accessing their money in retirement. 

‘The end result of this change is that many more people will now be brought into scope for inheritance tax.’

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, says: ‘The generous treatment of pension death benefits has long been considered low hanging fruit for a government in search of cash. 

‘It’s a stance that has set it apart from other savings vehicles with the position where a death occurs pre age 75 particularly generous. 

‘It’s led to criticism that people were leaving their pensions untouched so they could be passed down the generations in a tax efficient manner rather than being used to provide an income in retirement.

‘Today that fruit has been plucked as pensions will now be made subject to inheritance tax.

‘It’s a decision that will upturn many people’s plans as we will see many more people being dragged into paying inheritance tax.

‘We will see a flurry of people revisiting their retirement finances. The likelihood is we will see people looking to gift more money to loved ones while they are still alive – for instance money to help people get on the housing ladder. They will also look to spend down their pensions as retirement income rather than leave them untouched.’