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

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

Pensions will be included in assets that count towards the 40 per cent inheritance tax from April 2027, causing confusion for family inheritance plans.

What does it mean to include pensions in inheritance tax?

Adding unspent pension funds to inheritance tax calculations means many more estates will exceed the thresholds in the future.

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

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

But the Chancellor revealed she would organize an inheritance tax raid on unused pension funds.

Adding pension funds to inheritance tax calculations could also mean more people are forced to lose part of their nil residency rate band, which is phased out on estates worth more than £2m.

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

This is expected to affect around 8 per cent of properties each year and raise £640 million in 2027/28, £1.34 billion the following year and £1.46 billion by the third year of the laws. new rules.

How pensions could beat inheritance tax

Previously, the taxman treated retirement savings more generously, especially if people died before age 75.

They have therefore been widely used in inheritance tax planning, and advisers often recommend that, for wealthier families, pensions be spent last, if 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 funds currently pay no tax if the owner dies before age 75, although there are complicated rules to be aware of, especially for larger funds.

They must pay their normal income tax rate on withdrawals if the owner dies at age 75 or older. This means that the rates for withdrawing money from pensions in this case could be 20 percent, 40 percent or 45 percent.

In the case of annuities, the principal is typically lost anyway after you and your spouse die, although there are exceptions.

Final salary pensions also usually end upon the death of the holder or his or her surviving spouse. Read about the current rules on legacy pensions here.

Inheritance tax planning will change, experts say

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

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

‘This represents a fundamental shift in the way the wealthiest people 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 superannuation analysis at Hargreaves Lansdown, says: ‘The generous treatment of death pensions has long been seen as low-hanging fruit for a cash-hungry government.

‘It is a stance that has differentiated it from other savings vehicles, as the position where a death occurs before the age of 75 is particularly generous.

‘This has led to criticism that people were leaving their pensions intact so they could be passed down from generation to generation in a tax-efficient way, rather than using them to provide income in retirement.

‘Today this fruit has been reaped, since pensions will become subject to inheritance tax.

‘It is a decision that will change many people’s plans as we will see many more people forced to pay inheritance tax.

‘We will see a rush of people reviewing their retirement finances. We will most likely see people wanting to gift more money to their loved ones while they are still alive; for example, money to help people move up the housing ladder. “They will also look to spend their pensions as retirement income rather than leaving them untouched.”