Chancellor John Healey is set to press ahead with Rachel Reeves' plan to charge inheritance tax (IHT) on unused pensions from April 2027. The policy, which was announced in Reeves' maiden Budget in October 2024, means pensions that were previously outside IHT could soon become part of your estate when you die.
Double tax charge warning
Rachel Vahey, head of public policy at investment platform AJ Bell, said the plans could create a particularly nasty double tax charge. “Pensions will be taxed once under IHT as estate capital, and a second time as income tax on the beneficiary.” Some people could end up handing a staggering two-thirds of their pot to HMRC.
In practice, IHT is charged at 40% if total assets exceed the £325,000 nil-rate band and £175,000 residence allowance (which applies when passing the family home to children and grandchildren). If the policyholder dies at age 75, beneficiaries will be charged income tax on withdrawals. A beneficiary paying 20% basic rate income tax could face an effective total tax charge of 52%. This rises to 64% for higher-rate 40% taxpayers, while those on the additional 45% rate could face a staggering 67% tax rate.
Scope and impact
This applies to the part of the pension that exceeds the available IHT allowance. It won’t apply where the beneficiary is a spouse or civil partner, and it doesn’t affect final salary pension schemes. The changes are due to take effect from April 6, 2027, and are expected to raise £1 billion a year for the Treasury.
While most estates will still have no IHT liability, HMRC estimates around 38,500 families will soon pay more tax than they would have done previously. The House of Lords has described the policy as complex and unworkable, warning that it will cause significant anxiety and expense for those affected.
Unfair treatment of pensions
Vahey has highlighted another problem in a technical note issued by HMRC. “It is planning on operating a two-tier IHT regime that penalises pensions unfairly compared to other assets.” Some valuable IHT reliefs won’t apply to assets sitting inside a pension. They include ‘loss on sale relief’, which can allow executors to reduce IHT if qualifying investments fall in value between death and sale. HMRC says this relief won’t apply to qualifying investments held inside a pension. That could prove particularly painful if the stock market plunges after someone dies. The pension could be worth far less by the time it’s sold, but HMRC won’t give the estate the same tax relief for that loss.
Business property relief and agricultural property relief can also reduce the taxable value of qualifying business or agricultural assets, but those reliefs won’t apply to pensions either. There’s another practical problem: executors can normally pay IHT on a business property in instalments, giving families time to raise the money without having to sell valuable assets. That flexibility won’t be available where the relevant property is held inside a pension.
Vahey said: “The result is an unfair and unnecessarily complex system.”
What to do
Don’t panic and start emptying your pension. Most still won’t have enough assets to get caught in the IHT net. Many of those reliefs only applied to business assets held in a pension. But if your estate is in the danger zone, review your plans and consider whether sensible gifting or other estate-planning steps could reduce your exposure.
There's now little chance that Healey could reverse course in the Budget. From next April, our pensions will be fair game for HMRC.
