The Government says the changes will ‘remove distortions’ in the system
Families have been urged to plan ahead as a major new tax on pensions is coming in soon. Chancellor Rachel Reeves announced at last year’s Autumn Budget a major expansion of inheritance tax, so the levy will soon apply to pensions. The exact details of how this will work have yet to be confirmed.
A previous Government consultation on the plans provided an outline of what the changes will mean. The document explains: “Most unused pension funds and death benefits will be included within the value of a person’s estate for inheritance tax purposes and pension scheme administrators will become liable for reporting and paying any inheritance tax due on pensions to HMRC.” Chris Ball, CEO of financial advisory firm Hoxton Wealth, urged pension savers to plan ahead for the changes.
He said the change will be prompt a “major shift” in how people need to think about their long-term finances. He said: “Anyone likely to be affected should start reviewing their arrangements now, which means reviewing who you’ve named to inherit your pension, considering whether to draw down more during retirement rather than leaving large untouched pots, and weighing up the use of other tax-efficient vehicles such as ISAs or lifetime gifting strategies.”
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With many pension schemes, there is a form called an ‘expression of wish and nomination’, where you can nominate who you would like your pension to be passed on to if you don’t draw down from it. This is not legally binding on the pension provider, but they will take into account your wishes when deciding who to pay out your pension to.
How much could inheritance tax on pensions be?
Inheritance tax is levied at 40 percent on the total assets you pass on when you die. There are several individual allowances which mean you can pass on up to a certain amount tax-free, including a standard £325,000 allowance, as well as a £175,000 allowance if you are passing on your main residence to a direct descendant.
So if you had a £10,000 pot of pensions when you died, if the whole amount was subject to inheritance tax, your successors would have to pay £4,000 in tax. Mr Ball said the change in the rules is frustrating for people who have built up their pensions hoping to pass them on tax-free.
He said: “There is understandable frustration among savers who have contributed for decades under the assumption that pensions would remain outside inheritance tax. While Governments can change tax policy at any time, altering long-standing expectations always risks feeling unfair, particularly for those near retirement with limited scope to adjust.”
Pensions are set to become liable for inheritance tax from the start of the 2027/2028 tax year, from April 6, 2027. Asked if the Government could delay bringing in the new policy, Mr Ball said: “The April 2027 start date could theoretically slip if the policy detail isn’t ready.
“This has happened with complex pension rules before, but people shouldn’t rely on a delay.” He said the bigger question is whether the tax advantages around pensions should be trimmed.
He said: “There’s a balance to strike. Incentives must be attractive enough to encourage retirement saving, yet not so favourable that pensions become purely an inheritance planning tool. If the government feels the pendulum has swung too far, it may look to tighten reliefs elsewhere rather than rely solely on IHT.”
Lord Livermore, financial secretary to the Treasury, said in a debate in the House of Lords on the matter this week: “The Government continue to incentivise pension savings for their intended purpose of funding retirement. Most unused pension funds and death benefits payable from a pension will form part of a person’s estate for inheritance tax purposes from 6 April 2027.
“This removes distortions resulting from changes made over the last decade, which have led to pensions being openly used and marketed as a tax planning vehicle to transfer wealth, rather than to fund retirement.”
