The measure has prompted criticism because pensions will be treated differently from certain other inherited assets, including property and shares. According to GB News, qualifying property and securities can in some circumstances benefit from loss relief when they are later sold for less than their value at the date of death, while inherited pension funds will not receive the same treatment.
Pension Funds Will Form Part of the Estate for Inheritance Tax
From April 2027, unused pension funds will be included when calculating the value of a deceased person’s estate. Inheritance tax is normally charged at 40 per cent on the portion of an estate above the available tax-free thresholds. The standard allowance is £325,000 for an individual. It can potentially rise to £500,000 when a qualifying home is passed to direct descendants, while married couples and civil partners may be able to transfer unused allowances to the surviving partner.
According to The Times, the tax impact can become more severe when inherited pensions are also subject to income tax. Where the pension holder dies after the age of 75, beneficiaries may have to pay income tax when withdrawing the inherited pension, on top of any inheritance tax affecting the estate.
Calculations cited by The Times from accountancy firm RSM showed an extreme case in which a 48 per cent taxpayer in Scotland could receive £29,900 from a £350,000 pension pot. A beneficiary in England or Wales paying the 45 per cent income tax rate could receive £36,800. The paper said the highest effective tax burden could reach 91 per cent in a particular scenario where the pension increased the estate beyond £2 million, causing the loss of the residence nil-rate band available to a married couple.
Families Cannot Claim Loss Relief When Pensions Fall in Value
The incoming rules also create a difference between pensions and some other assets after death. Families may be able to recalculate inheritance tax where qualifying property or shares are sold for less than their probate value, but no equivalent relief will apply to pension funds.
GB News gave the example of a home valued at £500,000 at death, with only the £325,000 standard allowance available. The taxable amount would be £175,000, producing a £70,000 inheritance tax bill. If the property were later sold for £475,000, the lower value could reduce the taxable amount to £150,000 and cut the bill by £10,000.
According to Rachel Vahey of AJ Bell, HMRC’s reasoning is difficult to reconcile because pension assets are being included in the estate for inheritance tax even though the deceased is not regarded as having owned those underlying assets. Adam Cole of Quilter said the policy was bringing together two complex areas of taxation within a short period. Olly Cheng of Rathbones described the wider change as a move towards making pensions serve more narrowly as retirement income.
Property loss relief is generally available when qualifying inherited land or property is sold within four years of death. For qualifying shares and securities, the relevant period is generally 12 months.
