Martin Mathewson always planned to hand his hard-earned pension down to his only son, safe in the knowledge that it wouldn’t be subject to inheritance tax. With this in mind, the 81-year-old hasn’t touched his £762,000 pension pot since gaining access to it more than 20 years ago.
But Martin’s carefully laid plans have been torn apart by an upcoming tax raid from Chancellor Rachel Reeves, who is making pensions liable for inheritance tax.
From April 2027, the value of pension pots will be included in estates and caught in the net of inheritance taxes. This means thousands of families, including Martin’s, will be dragged into paying the dreaded death duty for the first time at a rate of 40pc.
Many will be caught out by a nasty double tax trap, effectively paying tax twice on pension savings, and face a huge administrative burden, experts warn.
Martin, a retired TV news cameraman from Surrey, says that instead of leaving his son a sizeable pension, he will now be landing him with a big inheritance tax bill – potentially of up to £304,800.
Martin spent decades building up his private pension but now feels he would have been better off spending it or handing it over to his son long ago.
He is one of the many Money Mail readers who have written in to vent their outrage over their retirement savings being decimated by incoming changes to inheritance tax.
He says: ‘For 20 years I have never had the need to draw down from my pension. I rested secure that on my death my pension would go to my wife, and on her death, it would go to our son. But I now find I don’t have enough years left to spend it or gift this money away without having to pay virtually 40 per cent tax on it all. It’s going to go into Government coffers and I feel cheated.’
What is changing?
Thousands of savers like Martin risk sleepwalking into large inheritance tax bills on their estate from next spring.
Families can pass on up to £325,000 after death free of inheritance tax – known as the nil-rate band. Inheritance tax is levied at 40pc on anything above this threshold. A married couple can hand over a combined £650,000 before their assets become liable for death duties.
Martin Mathewson fears his son will face a double tax hit on the pension he will inherit
If you are passing on your home to direct descendants, such as a child or grandchild, your allowance increases to £500,000 – or £1million for a couple.
For years, pensions have been seen as a useful tool for estate planning, as they do not currently form part of an estate and are therefore not subject to any inheritance tax, unlike money kept in savings or investment accounts.
Many workers have piled money into their pensions with this in mind. However, from next April, pension savings will form part of an estate and anything exceeding the allowance will be taxed at a flat rate of 40pc.
It means thousands face a dilemma over whether they should alter their financial affairs late in life to try to protect their families from a large bill.
Double tax trap
Loved ones also face a double tax hit on the inherited pensions, experts warn.
Those who die after the age of 75 will see their pots hit by both inheritance tax and income tax levied on beneficiaries. This is because when someone dies over the age of 75, their beneficiaries also have to pay tax at their normal rate of income tax – 20pc for basic-rate taxpayers, 40pc for higher-rate and 45pc for additional-rate taxpayers. More people than not die over the age of 75, so if they are liable for inheritance tax their families could face this extra pension levy.
For a 40pc taxpayer this represents a 64pc tax rate – and as withdrawals from the unused pension pot will be added to other income, some taking larger sums may find themselves tipped into this higher tax band.
Martin fears his son will face this double whammy because he is a higher-rate taxpayer.
Modest savers to be caught in the tax net
Tens of thousands of families who have saved up larger pensions will be affected, even if they wouldn’t traditionally be considered wealthy.
Shaun Moore, tax and financial planning expert at financial services firm Quilter, says: ‘Today, a married couple with a £600,000 home, £450,000 in pensions and £150,000 in savings would pay no inheritance tax at all.
Shaun Moore at Quilter
‘Although their combined wealth is £1.2million, pension assets are currently excluded, leaving a taxable estate of £750,000, which is comfortably within their combined nil-rate bands.’
That all changes after April next year, when the same couple would leave their children facing a bill of £80,000, once their pensions are included in the calculation, says Moore. In reality, the tax bill will be even larger as these calculations do not account for growth in the value of the house, pension or investments over time.
The situation is made worse by the fact the nil-rate band has been kept unchanged at £325,000 since 2009 and will remain frozen until 2031.
The Government is expected to have raked in £9billion in inheritance tax in 2025/26 – an extra £400million (4.6pc) on the previous year, according to the Office for Budget Responsibility.
But it forecasts this will soar to £15billion by 2030/31. This will be driven mainly by rising house and share prices, a growing proportion of deaths subject to inheritance tax, and the new levy on pension pots.
The Government estimates that out of 213,000 estates with unspent pension wealth in 2027/28, some 10,500 – around 1.5pc – will become liable for inheritance tax when they would not have done before.
Around 38,500 estates will pay more inheritance tax than they would have done otherwise, with their average liability rising from £169,000 to £203,000, according to its calculations.
Inheritance plans upended
Retired banker John Haynes is angry his carefully laid plans to leave his pension to his son and daughter have been scuppered by what he calls the ‘envy politics’ of inheritance tax.
The 64-year-old from Surrey took financial advice and transferred his final salary pension to an invested retirement pot six years ago.
A final salary pension, known as a defined benefit pension, pays a guaranteed income for life but dies with the pension holder. However, you can choose to cash out one of these pensions by taking out a lump sum and putting it into an invested retirement pension pot. Any unspent money can then be transferred to loved ones upon your death.
Many savers say their plans have been scuppered by what he calls the ‘envy politics’ of inheritance tax, amid changes being brought in by Chancellor Rachel Reeves
But all John’s diligent homework is going out the window with the upcoming changes.
He says: ‘One of the main attractions of the Sipp [self-invested personal pension] was that the full fund would be passed down the generations outside inheritance tax.’
John now plans to change the way he manages his pension to reduce the size of his estate, which also includes his home, savings and investments.
His children are 40pc taxpayers and will fall into the ‘double tax’ trap after he turns 75. So, instead of leaving the money in his pension pot, John will start to withdraw money, up to £50,270 a year when combined with his own income, once he reaches age 75. This means he will remain a basic rate taxpayer and pay just 20pc tax on the pension income. He will use this money to top up his children’s pensions, on which they will receive tax relief.
Some face an even bigger tax hit
Widower Andrew Jones built a substantial financial legacy from almost nothing over the course of his working life but is now in a quandary about how to protect it from inheritance tax.
Andrew, 73, says: ‘I left home at 16 and joined the Merchant Navy. I had £5 in my pocket that my father gave me.’
After spending decades paying as much as possible into his pensions with the aim of providing a comfortable retirement for him and his wife, this dream sadly ended when she died seven years ago.
And now he fears their savings will be hit with punitive death duties on an estate that includes two pension pots, Isas, his main property and a holiday home.
Andrew, who asked for his name to be changed, will find his estate is hit a lot harder than most because he and his wife had no children. This slashes their joint allowance and means whoever he leaves his money to faces paying a lot more inheritance tax.
He says: ‘We had no children so a total of nine nieces and nephews will eventually benefit. But I object to giving any of my assets away in tax to the Government.’
Act now before it’s too late
Adding pensions into estates will increase the administrative burden on grieving families, creating more paperwork, complexity and potential delays at an already difficult time, warns Shaun Moore of Quilter.
Heather Rogers, founder of Aston Accountancy, emphasises the importance of getting help from a reputable professional. She says it is impossible to give ‘one-size-fits-all’ advice on the best approach to minimising death duties.
She says: ‘Everyone’s circumstances are different. What may be pertinent advice for you, may be disastrous for someone else.’
There is one further crucial point that Rogers stresses for those keen to reduce the value of their estates just to thwart the taxman: ‘The most important person is you: always put your needs first.’
There are a number of ways you can lessen the inheritance tax hit on your finances
Jason Hollands, of wealth manager Evelyn Partners, says with one year to go until the changes which will bring pensions into inheritance tax, now is the time to start reviewing your financial plans.
‘Pensions will no longer offer the same estate planning advantages and in contrast could potentially face a very disadvantageous tax treatment on death,’ he says.
Six ways to avoid leaving loved ones with a large IHT bill
Spend your pensions
If you want to make sure your money is enjoyed and doesn’t go to the tax man – and you can afford to do so – you can spend your pension while you’re still alive. You can take the first 25pc of your pension tax-free.
But make sure you don’t run out of money too soon. And keep income tax thresholds in mind. You might inadvertently end up with a large tax bill even sooner if you withdraw too much at once.
Gift to loved ones
If you live for at least seven years after making a gift to loved ones, that money becomes exempt from inheritance tax.
You can also gift £3,000 a year, plus make unlimited small gifts of up to £250, free from inheritance tax.
If you die before seven years are up, inheritance tax is levied on a sliding scale – starting at the full whack of 40pc if it’s within the first three years.
You can also make unlimited, regular gifts free of inheritance tax but only if you can prove it’s coming out of spare income.
Buy life insurance
If you purchase life insurance and put it in trust, your loved ones can get a payout straight after your death – and that money is free of inheritance tax.
But be mindful that premiums can be high, especially as you get older, and if you cancel a policy, you immediately lose all the benefits of taking it out in the first place.
Change your will
You can pass on an unlimited amount to your spouse free of inheritance tax. So, if you planned to leave your pensions to your children, you could consider switching it to your spouse instead to delay and minimise the eventual tax bill. Your spouse could begin to make gifts to your children using this money.
Get an annuity
You can use your pension fund to buy an annuity, which provides a stream of income for life in exchange for a lump sum.
The money is then no longer in your estate. But as they’re a type of insurance policy, you won’t get any remaining funds back when you or your partner dies (unless you pay extra for value protection or guarantee payments for a certain number of years).
A healthy 65-year-old with £100,000 in their pension can currently lock in income of £7,821 a year, according to Hargreaves Lansdown.
An annuity can be a helpful way of creating predictable surplus cash to give away. So long as your gifts are regular, out of your income and do not impact your standard of living, you can give away as much as you like. Gifts will be out of your estate immediately – you won’t need to live a further seven years before they become tax-free.
Set up a trust
Trusts allow you to give away money during your lifetime, but to retain some control over how the money might be used. They can be a good way to pass money to children or grandchildren.
But you usually cannot continue to benefit yourself from what has gone into it if you want the contents to be free of inheritance tax.
You need to be wealthy to make the costs, taxes and hassle worthwhile, and you should get expert advice from a professional like a lawyer.
Check the lawyer is regulated at sra.org.uk/consumers/register. Experts warn people are being encouraged to set up trusts unnecessarily by unregulated firms, who might even appoint themselves as a trustee without telling you.
Will you be affected by the tax changes? Email moneymail@dailymail.co.uk