This shift marks a departure from current rules, where most defined contribution pensions can pass to beneficiaries free from inheritance tax. Critics say the change risks not only affecting high-net-worth individuals, but also many middle-income families trying to build long-term security.
New Tax Inclusion Raises Concerns Over Early Withdrawals and Pension Erosion
Under the current system, pension pots are typically excluded from inheritance tax due to their non-estate status. This has long positioned pensions as one of the most tax-efficient vehicles for intergenerational wealth transfer. According to Baroness Ros Altmann, former pensions minister, Labour’s proposal would be “a total disaster for future pensions.”
Altmann warns that individuals may begin withdrawing large sums from their pension funds earlier than necessary, to avoid potential future tax charges. “The measure will be a total disaster for future pensions, with people rushing to withdraw as much as they can, as soon as they can, particularly up to the annual £50,270 higher rate income tax threshold, with less money going into pensions, and millions more poorer future pensioners.” she said.
This behaviour, she argues, would result in lower pension contributions overall and fewer funds available in retirement, increasing the risk of financial hardship for future pensioners.
While details of the policy have not yet been finalised, the concern lies in the disincentive it could create to save for retirement. Many older savers might choose to take money out of their pensions prematurely and store it in taxable accounts or other vehicles, undermining the long-standing principle of pensions as tools for lifetime income.
According to the Institute for Fiscal Studies (IFS), any decision to bring pensions under IHT could have far-reaching consequences for savings behaviour. The think tank estimates the Treasury needs to raise at least £22 billion in the next Budget to meet fiscal targets. If the proposed scrapping of the two-child benefit cap goes ahead, the figure could climb further.
Political Split Emerges Over Funding Methods for Fiscal Shortfall
The proposed change comes as part of a broader debate on how to manage the UK’s fiscal pressures. Reeves has signalled her intention to explore targeted tax increases, saying those with the “broadest shoulders” should contribute more. This language has been widely interpreted as a nod towards taxing the wealthy, though exact measures remain undefined.
The Conservative Party has pushed back firmly, urging cuts to government spending rather than raising taxes. Sir Mel Stride, Shadow Chancellor, has called on Reeves to “cut the welfare bill” instead of introducing new taxes. “Avoid the need to break your promise and raise taxes again,” he stated, referencing Labour’s previous commitments to limit tax hikes.
In practice, the clash reveals deeper ideological divisions. Labour appears focused on redistributive mechanisms to balance the budget, while Conservatives favour limiting state spending to reduce the burden on taxpayers.
Industry groups, meanwhile, have urged caution. Several financial advisers and pension providers have voiced concern that the proposals, if implemented, could create administrative complexity and legal grey areas around what qualifies as an “unused” pension.
