Rules are changing (Image: O2O Creative via Getty Images)
Families could lose as much as 67p from every £1 inherited from a pension under forthcoming tax changes, a financial adviser has warned. From April 6, 2027, most unused pension funds and death benefits will be included within a person’s estate for inheritance tax purposes.
According to Samuel Mather-Holgate, the change could expose some inherited pensions first to inheritance tax and then to income tax when the beneficiary withdraws the remaining money.
Samuel, managing director and Independent Financial Adviser at Mather and Murray Financial, said: “In the most extreme circumstances, your family could ultimately receive only around 33p from every original £1 in your pension. If the fund is first subject to inheritance tax at 40% and the remaining money is then withdrawn by a beneficiary paying income tax at 45%, the combined effective tax rate can reach 67%.
“That will not apply to every pension or every beneficiary, but it demonstrates why families should no longer assume pension wealth will automatically pass to the next generation tax-free.”
Pensions have often been preserved until last because they usually sat outside the estate for inheritance tax purposes. Retirees might therefore spend money held in ISAs, savings accounts and other investments first, leaving their pension untouched for their children.
It could be a problem for those left behind (Image: courtneyk via Getty Images)
Samuel explained: “For many people, preserving the pension was an established part of estate planning because it could be passed on particularly efficiently. Once pensions are included within the estate, that assumption changes significantly. Some retirees may need to reconsider the order in which they draw upon their assets.”
The reforms are expected to bring thousands more families into the inheritance-tax system. HMRC estimates that approximately 10,500 estates will become liable for the tax when they would not previously have paid it, while another 38,500 could face larger bills. The average additional inheritance tax liability among affected estates is estimated to be around £34,000.
Samuel said: “You do not necessarily have to feel rich to have an inheritance-tax problem anymore. A long-held family home, a reasonable pension and some savings or investments can be enough, particularly when tax-free allowances remain frozen while the value of those assets continues to rise.”
House prices can make the problem particularly acute. In some areas, an ordinary family home may consume much of the available inheritance tax allowance before pensions, savings and investments are counted. But Samuel warned retirees against immediately withdrawing or giving away pension savings purely to reduce a future tax bill.
He said: “People should not make irreversible decisions based on one tax consideration. Taking money from a pension can create an immediate income tax liability, while giving it away could leave you without enough to support yourself later. Your own retirement security must remain the priority.”
He recommends reviewing wills, pension nominations and the likely value of the entire estate before the new rules take effect.
He added: “Inheritance tax is increasingly becoming a mainstream planning issue rather than something affecting only the extremely wealthy. The important thing is to understand whether your family could be affected and consider the options early. The worst response would be to ignore the change until it is too late to plan properly.”
