Inherited pensions will be subject to inheritance tax from 2027, Chancellor Rachel Reeves announced in Wednesday’s Budget, in a move that will require many to rethink their estate planning strategies.
Currently, defined contribution pensions can be inherited tax-free if the person dies before age 75 and are taxed at an individual’s marginal rate of income tax if the person dies after age 75.
However, Reeves said she would “close the loophole” created by the previous government made even bigger when the lifetime allowance was abolished, by bringing inherited pensions into the IHT net.
Pension experts warned that the changes will come with “substantial challenges” for financial planning and said that the Chancellor will “inevitably face accusations of hitting beneficiaries with a new death tax.”
Tom Selby, director of public policy at AJ Bell, said: “A major obstacle centres around how to treat people who have made decisions about their retirement pot based on the pensions death tax rules as they are today. There will, for example, be people who chose to transfer defined benefit pensions into a defined contribution scheme in part because they wanted to prioritise passing money on tax efficiently to loved ones.
“Anyone who made larger contributions into their defined contribution pension to make the most of the existing rules will also now be wondering what could happen to their pot when they die.”
Selby warned that many people will be left feeling like “the rug had been pulled from under them” and pension savers will be facing complex decisions in the next few years.
In addition, the Chancellor announced that the freeze on IHT thresholds will be expanded by two years until 2030.
Following the announcement, the Office for Budget Responsibility’s forecast for inheritance tax revenue was revised upwards to reflect the current and future expected value of IHT to the Treasury.
Between 2024-25 and 2028-29, the OBR estimates the Treasury will collect £50.55 billion, representing an increase of £8.42 billion more than the £42.13 billion forecast in ex-Chancellor Jeremy Hunt’s Spring Budget earlier this year.
Stephen Lowe, group communications director at Just Group, said: “The latest HRMC figures on the amount of inheritance tax collected point to another record year in revenue, with the half-year total announced last week exceeding the same period last year by £396 million. The freeze in IHT thresholds, coupled with any growth in property prices will likely drag more estates into the IHT bracket and underscores the importance for people to stay on top of the value of their estate and estate planning.
“As the dust starts to settle on the Budget, we would urge individuals to seek an up-to-date estate valuation to understand any potential IHT liability.”
