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The government has confirmed it is pushing ahead with plans to make unused pensions subject to inheritance tax.
It means more families will be dragged into paying inheritance tax (IHT) as defined contribution pensions will be counted as part of an estate from April 2027, potentially exceeding the £325,000 nil rate band and making IHT due at 40% on amounts above that threshold.
And we now have more details about how the plans will work. We’ll explain the key points below.
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There were 649 responses to the government’s consultation, many of them expressing concerns about the plans. Some respondents suggested a different flat rate tax on pensions, instead of bringing them into the scope of inheritance tax.
But not much has changed from the plans first put forward in the autumn Budget – with a couple of notable exceptions.
The government wants to bring an end to a tax loophole which was created by the pension freedoms of a decade ago. Those freedoms meant people no longer had to buy an annuity with their pension savings, and so they could build up pension pots to pass on wealth to the next generation free of inheritance tax. Before that, people would have taken out an annuity which died with them (or with their spouse, if it was a joint annuity).
The government consultation response said: “The policy objective is to remove distortions resulting from changes to pensions tax policy in the last decade, which have led to pensions being openly used and marketed as a tax planning vehicle to transfer wealth. The announced reforms also remove inconsistencies in the inheritance tax treatment of different types of pensions.”
David Fenwick, technical probate lead and senior solicitor at Co-op Legal Services, which partners with Saga Legal, says that the changes are now a near-certainty, with the legislation having now been drafted.
He adds: “Pensions were never intended to be used for estate planning, they were intended to be tax-efficient for providing for the individual during their lifetime. The legislation has been carefully crafted to remove any real benefit in keeping money in a pension pot for IHT-saving purposes, but pensions do still provide the same lifetime benefits that they always have done.”
Helen Morrissey, head of retirement analysis at wealth firm Hargreaves Lansdown, said: “The generous treatment of pension death benefits has long been considered low-hanging fruit for a government in search of cash. Now that fruit has been plucked as pensions will now be made subject to inheritance tax.”
The changes won’t affect everyone. If you have a defined benefit pension, such as a final salary pension, you won’t be affected, as these can’t usually be passed on.
The ‘spousal exemption’ – which means anything left to a spouse or civil partner is exempt from inheritance tax – will apply to pensions too.
The government says there an estimated 213,000 estates per year with inherited pension wealth. That’s a much larger number than the number of estates currently liable for IHT (27,800 taxpaying IHT estates in 2021-22, estimated to rise to 37,000 by 2016-27.)
But because of exemptions like the nil rate band and the spousal exemption, the government estimates that only 10,500 estates will have an IHT liability because of pensions, which would not have had one otherwise. The government says around 38,500 estates will pay more IHT than would previously have been the case.
Around 8% of estates will be affected by the changes to IHT on pensions. Currently, only about 4% of estates pay IHT. The average IHT liability is expected to increase by around £34,000.
The change is predicted to raise about £640 million for the exchequer in 2027-8, rising to £1.34 billion in 2028-29 and £1.46 billion the following year.
The issue of ‘double taxation’ of inherited pensions is now looking very real. Where the total size of the estate is over the IHT threshold, pensions will be liable for 40% IHT, followed by an income tax bill for drawing the remaining benefits (if the original pension-holder died after the age of 75).
Rachel Vahey, head of public policy at wealth platform AJ Bell, said: “Once passed to the beneficiary, income withdrawn from the pension may then also be subject to income tax at their own marginal rate, depending on the age of the member when they died.”
“The double taxation proposed means that pension assets will be subject to a 64% effective tax rate on death where the pension pot exceeds the IHT nil rate band allocated to the pension and the beneficiary is a higher-rate taxpayer,” she added.
Concerns that inherited pensions could be subject to almost 90% tax – in extreme cases – from April 2027 have not been alleviated by the new details published by the government.
The very highest effective level of tax could affect those with estates worth £2 million to £2.7 million, including unused pension savings. That’s because above £2 million, you start losing the £175,000 IHT allowance that applies if you leave a property to your children or grandchildren. The allowance ‘tapers’ down between £2 million and £2.35 million, or £2.7 million for a married couple.
Steve Webb, former pensions minister and now partner at consultancy LCP, said: “Nothing has changed in this regard. There’s still a risk in the largest estates that having a pension on top could mean your nil rate band is tapered down on top of the marginal rate referred to above, making a total 87% rate possible.”
HMRC has made one big change to its proposed approach to applying IHT to pensions. Instead of pension scheme administrators handling the reporting and payment of IHT on unused pension funds on death, this responsibility will shift to the personal representative of the estate. That means the executor, if there’s a will, or the administrator, if there’s no will.
Vahey said: “This may alleviate some of the problems with the initial proposal, as beneficiaries might be able to pay the whole IHT bill from other estate assets, possibly resulting in a faster settlement. But it by no means creates a simple process.
“Bereaved and grieving families will still have to grapple with the additional complexity and confusion caused by adding unspent pension funds into the IHT liable assets. Rather than saving them from a tortuous process, this feels like HMRC is doubling down by pushing even more problems firmly onto the plate of the bereaved to solve,” she added.
There will be a digital service and an online calculator to help. The personal representative (executor) will assemble values of all the pensions plus all other assets and put the information into this calculator. It will then tell the executor the total IHT bill (if any) and allocate the total to different aspects of the estate.
Webb said: “They will have a lot of work to do to get all this sorted while other things are happening in their life like sorting out funerals, perhaps dealing with care needs of a surviving parent etc, to say nothing of their emotional needs.
“I strongly suspect that people will be reluctant to take this on, and/or that solicitors and others will get increasing take-up of services to do this for people.”
Fenwick said: “Executors will have to ensure they apportion the tax liability properly between the estate and the pension fund (along with any other existing taxable entitles, such as trusts). It would be highly recommended that they engage a professional probate practitioner to assist with this when the estate will be subject to inheritance tax.”
Many respondents to the consultation suggested extending the 6-month deadline for paying IHT, since adding pensions into the mix could make the process slower and more complicated. But the government has said that the deadline will not change. Missing the deadline can mean fines as well as interest charges.
Webb said: “It may be very difficult for an executor to meet these deadlines if, for example, pension providers are slow to respond to correspondence or unexpected pensions are found in paperwork months later, or if beneficiaries are unwilling or unable to engage.”
We now know more about the process people will go through to pay inheritance tax on any inherited pension benefits.
Once the beneficiaries of the pension wealth receive it, they will become liable (along with the executor) for any inheritance tax being paid.
Shaun Moore, tax and financial planning expert at Quilter, said: “If the tax is paid through the pension provider, it won’t count as income, so there’s no extra income tax to worry about on the IHT element.”
However, he added, if the beneficiary does not instruct the provider to pay the tax due, they may end up paying income tax on all the benefits they receive. “In this scenario, pension beneficiaries will need to contact HMRC to request a refund of income tax.”
If you’re thinking about your estate’s future IHT liability and keen to put your affairs in order, Fenwick suggests that there is something you could do to make it easier. “Individuals with pensions could arrange to request that the pension pot is paid out to the executors to hold for the estate, if their intended recipients are the same as those inheriting under their will. This would make it easier for the executors to deal with the tax.”
It’s been confirmed that death in service benefits payable from both discretionary and non-discretionary registered pensions schemes will be excluded from inheritance tax. There had been concerns that some types of death-in-service benefits might be liable for IHT, but this will not be the case.
It has also been confirmed that where someone has taken out a joint annuity for themselves and someone else, the annuity that is paid to the survivor will not be liable for IHT.
Alongside the changes to pensions, the government has confirmed that it will press ahead with changes to business property relief and agricultural property relief. This will create an IHT liability on those assets if they are worth more than £1 million, although IHT will be charged at a lower rate.
The government estimates that this will affect around 0.3% of estates.
Moore said: “This essentially means that in addition to existing nil-rate bands and exemptions, a new £1 million allowance will apply to the combined value of property in an estate qualifying for 100% business property relief or 100% agricultural property relief.
“Any amount over £1 million will receive 50% relief,” he added, meaning IHT will be due at 20%.
Another change is that listed shares treated as unquoted shares, such as AIM-listed shares, and qualifying shares listed on foreign exchanges which are not a recognised stock exchange, will only get 50% IHT relief, not 100% IHT relief. These types of assets will not count towards the £1 million allowance.
There will be the option to pay IHT due on agricultural or business property in equal annual instalments over 10 years, interest-free.
The new rules will apply to lifetime transfers made on or after 30 October 2024 if the donor dies on or after 6 April 2026. So transferring a farm or business to someone else before the new law takes effect will not necessarily make a difference.
The next step is for the draft legislation to be passed to bring the changes into effect. This will be in the 2025-26 Finance Bill.
Some people are already considering changing the order in which they spend their money, in order to plan for tax. For example, spending pension money first, and money saved in ISAs or elsewhere later. This wouldn’t make a difference if they die before 75, but after 75 the ‘double taxation’ issue would apply to the person inheriting their pension wealth. Whereas an inherited ISA, for example, isn’t treated as income in the same way.
Making regular gifts out of income can also be an efficient way to reduce your potential IHT bill – but make sure you follow the rules correctly.
Fenwick, from Co-op Legal Services, says: “The new legislation does allow for pension pots to benefit from spouse or charity exemptions for IHT, so it may be worth checking any nominations or instructions to the trustees to pay to these types of beneficiary where appropriate. Large enough gifts to charities could reduce the overall rate of tax due on the estate and pension from 40% to 36%.”
Previously, it was relatively common tax planning for business premises to be owned by the owners’ pension fund, but this is set to change, Fenwick says.
“It appears that business property relief and agricultural property relief will not be available to any assets held in the pension fund, and so if any investments within the fund are held on assets that would otherwise qualify for these, there may be advantages in taking them out of the pension during the lifetime.”
It's important to get professional advice if you’re concerned about the impact of IHT on your pension.
Saga has partnered with HUB Financial Solutions, who can help you find the right annuity for you from the whole of market. If you take out an annuity using their service, Saga Money will earn a commission.
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