Finance analysts are urging the British public to take action in order to avoid being “double taxed” following recent policies introduced by Rachel Reeves. According to Evelyn Partners, beneficiaries of estates are risk of paying both inheritance tax and income tax
Earlier this year, the Chancellor has announced significant changes to IHT rules, with unused pensions and certain pension death benefits to be included in estate valuations from 2027. The move comes alongside a decision to freeze the nil rate band – the amount that can be passed on inheritance tax-free – at £325,000 until 2030, extending the freeze by two years.
What are the changes to inheritance tax?
These changes are expected to increase the proportion of estates paying IHT from the current five per cent to eight per cent, affecting approximately 28,000 estates annually. While the full details of how inheritance tax on pensions will work are yet to be finalised, individuals can still pass their pensions to beneficiaries without incurring a tax charge until April 2027.
Experts advise against rushing decisions about retirement savings before this deadline. Currently, pensions enjoy significant tax advantages, particularly since the abolition of the lifetime allowance. For those who die before age 75, beneficiaries can receive pension pot funds completely tax-free as income, without any limits.
This favourable treatment has led many pension savers to avoid accessing their pensions during retirement, choosing instead to spend other assets first. The Government’s stated aim is to maintain tax incentives for pension saving, such as tax relief on contributions. However, the new rules are designed to encourage people to use their pensions during retirement rather than leaving them untouched as a tax-free wealth transfer vehicle.
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An expert has shared a way families can cut down their inheritance tax bill in the wake of recent changes to pension rules
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How are Britons at risk of being “double taxed”?
Despite these changes, the impact will not be universal, with the majority of estates still expected to remain unaffected by inheritance tax. Ian Dyall, the head of Estate Planning at Evelyn Partners, warns that the new rules could lead to “double taxation” of pension pots in certain circumstances.
According to the estate planner, if the pension holder dies at age 75 or older, beneficiaries could face income tax at their marginal rate on withdrawals from pensions that have already been subject to IHT at 40 per cent.
For additional rate taxpayers at 45 per cent, this could result in receiving just 33p in the pound from inherited pensions – an effective tax rate of 67 per cent. The situation could become even more complex for larger estates, Dyall notes.
“If the addition of pension savings will push the total value of an estate over the £2million mark, then the residence nil rate band will start to disappear and IHT bills will become even more onerous,” he warned.
The Chancellor outlined changes to IHT during her Autumn Budget
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However, he cautions that potential inheritance tax savings must be weighed against the tax paid on pension withdrawals.
Experts note this is particularly important for savers near significant marginal tax steps or those paying the 45 per cent additional rate.
“We might see some savers accelerate the withdrawal of their 25 per cent tax-free lump sum, either to spend or even gift it to set the seven-year clock ticking,” Dyall said.
The strategy requires careful consideration of individual circumstances and tax positions, the tax expert claims. This is because retirees might need to shift their approach from preserving pension wealth to strategic withdrawal planning.
This represents a significant change from current practices where many retirees prioritise preserving their pension pots.
Dyall also outlined specific strategies for managing pension withdrawals under the new rules.
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Britons are looking for ways to protect their pension pots after recently announced tax changes
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One approach involves taking regular withdrawals from pension pots as income to make gifts using the “normal expenditure from income” rule.
These regular gifts could potentially be free of inheritance tax, though Dyall emphasises the rules can be “finicky” and professional advice is recommended. However, he warned against a common misconception regarding tax-free cash withdrawals.
“If you are trying to use the excess income exemption, what you can’t do is take all your tax-free cash, stick it in a bank account and gift it gradually from there, as then it will be seen as a gift from capital and not from income,” he explained.
This distinction between income and capital gifts is crucial for effective tax planning under the new rules.