Families are facing an inheritance tax raid on their pensions – what this means for your wealth

Chancellor Rachel Reeves has launched an inheritance tax attack on budget savers by making pensions liable for the levy.

Pensions will be included in assets that count towards the 40 percent inheritance tax from April 2027, throwing the family’s estate plans into turmoil.

However, wealthy families will be relieved that the seven-year rule on gifts – after which they disappear from your estate for inheritance tax purposes – was not extended to ten years as widely feared.

The current thresholds also remain unchanged, although a planned freeze until 2030 means more estates will end up in inheritance tax.

What does including pensions in inheritance tax mean?

By including unused pension pots in the calculations of inheritance tax, thresholds will be exceeded by many more inheritances in the future.

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

Wealthier families breathed a sigh of relief as the main nil inheritance tax rate remains at £325,000, while the £175,000 subsistence allowance for homes passed on to direct descendants is also retained. This means married couples can still pass on an inheritance of up to £1 million tax-free.

But the Chancellor announced she would file a tax return on unused pension pots.

Adding pension pots to inheritance tax calculations could also mean more people are pushed to lose some of their zero-rate housing benefits, which are being phased out on estates worth more than £2 million.

The government said it is “removing the opportunity for individuals to use pensions as a means of inheritance tax planning” by bringing unused pots within the scope of inheritance tax.

It expects this to affect around 8 per cent of estates each year, raising £640 million in 2027/2028, £1.34 billion the following year, and £1.46 billion in the third year the new rules come into force are.

How pensions can beat inheritance tax

Retirement savings used to be treated more generously by the tax authorities, especially if people died before the age of 75.

They are therefore widely used in inheritance tax planning, and advisers often advise wealthier families to spend pension pots last or not at all.

Pension and tax experts predict that a crackdown will lead to an increase in donations and perhaps greater use of trusts and insurance products.

Beneficiaries of most defined contribution pension pots currently pay no tax if the owner dies before the age of 75 – although there are tricky rules to be aware of, especially with larger funds.

They must pay their regular income tax rate on withdrawals if the holder dies at age 75 or older. This means that the rates for pension deductions in this case can be 20 percent, 40 percent or 45 percent.

With annuities, the capital is usually lost after the death of you and your partner, although there are exceptions.

Final salary pensions also generally end upon the death of the holder or their surviving spouse. Read here what the current rules are about inheritance pension.

Inheritance tax planning is about to change, experts say

“Pensions are seen as a useful wealth planning tool and there will be individuals and families who have approached retirement and estate planning based on existing rules,” said Mike Ambery, director of retirement savings at Standard Life.

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

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

‘The end result of this change is that many more people will now be subject to inheritance tax.’

Helen Morrissey, head of pensions analysis at Hargreaves Lansdown, said: ‘The generous treatment of death benefits has long been seen as low-hanging fruit for a government looking for cash.

‘It is a position that sets it apart from other savings instruments, where the situation where a death occurs before the age of 75 is particularly generous.

‘There has been criticism that people were leaving their pensions undisturbed so that they could be passed on from generation to generation in a tax-efficient manner rather than being used as income in retirement.

‘Today that fruit has been picked, because pensions are now subject to inheritance tax.

‘It is a decision that will turn many people’s plans upside down as we will see many more people dragged into paying inheritance tax.

“We will see a flood of people re-examining their retirement finances. Chances are we’ll see people wanting to give more money to loved ones while they’re still alive – for example, money to help people get into the housing market. They will also try to spend their pensions as retirement income, rather than leaving them untouched.”

Jon Greer, head of pensions policy at Quilter, said: ‘Abolishing the inheritance tax exemption will result in a double tax burden for beneficiaries, although the normal exemption for spouses and civil partners will continue to apply.

‘The pension is not only subject to income tax upon payment (if the deceased is over 75 years old), but is now also subject to inheritance tax.

‘For families inheriting larger pension pots, this will lead to significant tax liabilities depending on the recipient’s income tax bracket.’

He added: ‘While this move helps generate additional revenue to address the budget deficit, it also ultimately marks the government’s attempt to reduce pensions to solely a vehicle for retirement planning and not for inheritance tax planning.

“The problem, however, is that there will be many people who have planned their finances according to the previous rules.”