The UK government’s approach to inheritance tax (IHT) on pensions is set for a major change under Chancellor Rachel Reeves’ proposed reforms. As reported by Express.co.uk, Reeves’ autumn Budget outlined plans to apply IHT to unused defined contribution pensions from March 2027, which could mean that inherited pension pots are taxed twice—once through inheritance tax and again through income tax.
Financial experts warn that this change could result in families losing up to 67% of an inherited pension, leading many retirees to reconsider their financial planning strategies. The proposal represents a significant shift in how pensions are treated after death, and financial advisers are already advising clients on ways to mitigate the potential tax burden.
How the New Inheritance Tax Rules Will Affect Pensions
Currently, pensions passed on to beneficiaries are exempt from inheritance tax, allowing families to transfer wealth efficiently. Under the new plan, however, any unused pension savings will be subject to inheritance tax at 40% if the pension holder dies after March 2027. For those who pass away at age 75 or older, withdrawals made by beneficiaries will also be taxed as income, further reducing the amount inherited.
This potential double taxation could see pension pots lose up to 67% of their value, significantly impacting the financial future of those expecting to receive an inheritance. Claire Altman, Standard Life’s Managing Director of Individual Retirement, highlighted the urgency of the issue, stating that “the planned extension of IHT to pensions has had a profound effect on financial planning.”
What Pension Savers Are Doing to Avoid the Tax Hike
In response to these proposed changes, financial advisers are encouraging retirees to withdraw more from their pensions while they are still alive. A recent Standard Life survey found that nearly 70% of financial advisers are now recommending that clients increase their pension withdrawals to reduce future IHT liabilities.
Previously, many retirees left their pension pots untouched, preferring to live off other savings in order to pass down as much of their pension as possible to their heirs. However, this approach is now being reconsidered. Many retirees are choosing to spend more of their pension funds rather than risk excessive taxation, while others are exploring ways to distribute their wealth before their death.
Some pensioners are opting to gift money to their children and grandchildren in advance. Under the current rules, gifts made more than seven years before death are exempt from inheritance tax. This strategy requires careful financial planning, as gifting too much too soon could leave retirees short of funds for future healthcare or living expenses.
How to Reduce Your Inheritance Tax Bill
For those looking to protect their pension savings from the new tax changes, financial advisers recommend exploring legal strategies to minimise the impact of inheritance tax. One option is to take advantage of inheritance tax-free gifting allowances, which currently allow individuals to gift up to £3,000 per year without incurring tax.
Gifting from surplus income is another strategy that enables retirees to make unlimited regular payments to loved ones, provided that these gifts do not affect their standard of living. Charitable donations can also provide tax relief, as gifts to registered charities are entirely exempt from inheritance tax. Additionally, donating at least 10% of an estate to charity reduces the inheritance tax rate from 40% to 36%.
Some retirees are considering investing in business relief-qualifying assets, which can qualify for full inheritance tax relief if held for at least two years before death. Another method involves placing life insurance policies under a trust, ensuring that any payouts do not form part of the taxable estate.
For those who prefer a more structured approach, setting up a trust can help manage how assets are distributed after death, reducing the overall inheritance tax burden. However, trusts come with complex tax rules and require professional financial advice.
