Pension savers face a significant financial blow, with retirement funds set to be caught in a punishing “double tax” trap from next April.
The changes, first unveiled by Chancellor Rachel Reeves in her October 2024 Budget, will bring unused pension assets within the scope of inheritance tax for the first time.
This represents a dramatic departure from the current system, where unspent pension pots can be passed to loved ones without attracting IHT.
With less than twelve months until the new rules take effect, financial experts are urging savers to act swiftly.
Jason Hollands, Managing Director at wealth management firm Evelyn Partners, said: “April 2027 may feel some way off, but when it comes to financial planning, a year is not a long time. The changes on the horizon are significant and, for many people, will require a rethink of strategies that may have been in place for many years.
“Under the new rules which are set to go ahead next April, that benefit will be materially reduced, and in some cases, families could face a double layer of taxation.”
Previously regarded as one of the most tax-efficient vehicles for transferring wealth between generations, defined contribution schemes will lose much of their appeal as inheritance planning tools.
The tax treatment becomes particularly punishing when the pension holder dies after reaching 75, as beneficiaries must then pay income tax at their marginal rate on any withdrawals from the inherited pot.
For those in higher or additional rate tax brackets, this creates the prospect of extremely steep effective tax rates on inherited pension wealth.
The Government’s own projections indicate that 10,500 estates will face inheritance tax bills for the first time in the 2027-28 tax year
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GETTYMs Hollands commented: “For years, money-purchase pensions have been a cornerstone of estate planning because they could typically be passed on free of inheritance tax.
“The ability to leave an unspent pension pot to your loved ones tax free has been one of the few perks of having a defined contribution pension fund rather than a final salary defined benefit scheme where the risk sits on the shoulders of your employer.”
The Government’s own projections indicate that 10,500 estates will face inheritance tax bills for the first time in the 2027-28 tax year as a direct result of these pension changes.
A further 38,500 estates already liable for IHT will see their bills rise, with the average increase estimated at around £34,000.
Skipton suggests that achieving a comfortable retirement may require pension savings exceeding £200,000 | GETTY
Currently, inheritance tax applies only to estate values exceeding certain thresholds, with approximately four per cent of deaths triggering a liability.
The nil-rate band allows individuals to pass on £325,000 free of tax, with an additional residence nil-rate band of up to £175,000 available when leaving assets to direct descendants.
Many savers are already taking action to reduce their potential exposure to the new tax regime.
Gifting has also gained popularity
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GETTYSurvey data reveals that one in seven people have begun drawing down more from their pension pots in anticipation of the changes, with nearly half planning to follow suit.
Withdrawals of tax-free pension lump sums have reached a five-year peak, with 116,000 individuals aged 55 taking out sums totalling £2.3billion during 2024-25.
Gifting has also gained popularity, with one in five respondents reporting they have already increased lifetime gifts to family members, while two in five are contemplating doing so.