Government Urged to Review Inheritance Tax on Pensions

Chancellor Rachel Reeves announced in her October 2024 Budget that from April 2027, most pension savings will be subject to inheritance tax (IHT). This will end the current tax-free status of inherited pension pots, except when left to a spouse or civil partner.

Current Rules vs Planned Changes:

Now:

• Pension pots can be passed on IHT-free.
• If the pension holder dies before age 75, withdrawals by beneficiaries are also income tax-free.

From April 2027:

• Pension pots will be included in the deceased’s estate for IHT purposes.
• This could lead to taxes of up to 40% on larger estates.
• Spouses/civil partners still receive pensions tax-free, but cannot pass them on further without triggering tax.

Industry Concerns:

• Administrative Burden:
  Critics, including the Investing and Saving Alliance (TISA) (representing 270+ financial firms), warn that involving pensions in IHT adds stress and complexity for grieving families.
  Executors will have to coordinate with pension providers within a six-month deadline to avoid interest on late IHT payments.
• Behavioural Change Risks:
  Concerns that people might change how and how much they contribute to pensions, undermining long-term retirement planning.
• Fairness Issues:
  Critics argue that families with smaller pension pots (under £90,000) should be exempt to avoid disproportionately hurting lower-wealth households.

Proposed Alternatives (TISA & Oxford Economics):

• Exempt pension pots under £90,000 from both IHT and income tax, regardless of the deceased’s age.
• Introduce tax only on larger pensions, replacing the government’s universal IHT approach.

These alternatives are estimated to raise £1.3–£2 billion per year, aligning with the government’s revenue goals (targeting £1.46 billion annually by 2029–30).

Government Response:

The Treasury defended their plan, stating that:

• It aligns with pensions’ intended purpose — funding retirement, not passing on wealth.
• Over 90% of estates will continue to pay no IHT even after these changes.

Conclusion:

The government is under pressure from the pensions industry to reconsider taxing inherited pensions. While aiming to close tax loopholes and increase revenue, critics argue that the changes create unnecessary burdens on families and could have unintended consequences on pension behavior. Alternative tax models may achieve similar revenue with less disruption.

If you have any questions on the issues raised in the article, please get in touch with me, Aimee Bowles here. 

The government’s proposal to include pension funds within IHT risks creating unnecessary stress and delays for grieving families

https://www.thetimes.com/business-money/money/article/inheritance-tax-news-pensions-exempt-rachel-reeves-b38xw7gmx