UK households have been issued a stark warning about a looming 'double tax' on pensions, with the government detailing new rules that will apply from April 2027. The changes, announced by Chancellor Rachel Reeves, aim to include unspent pension funds within inheritance tax (IHT) calculations, effectively combining income tax and IHT to create a double levy on some families.
Six-Month Deadline for Tax Settlement
Wealth management firm Saltus highlights that families will have just six months to settle all tax owed on unspent pension pots after the estate holder's death. This tight deadline presents significant challenges, especially for estates with multiple pension pots or illiquid assets. Failure to meet the deadline will result in late payment interest accruing on outstanding tax.
Impact on High Net Worth Individuals
According to Saltus's latest Wealth Index, over a quarter (26%) of high net worth individuals (HNWIs) are considering strategies to protect their pensions from IHT. Additionally, 21% expressed concern about how the changes could affect the way they pass on pension benefits. Henrietta Grimston, a chartered financial planner at Saltus, advises that personal representatives must carefully divide the IHT bill to avoid disadvantaging beneficiaries.
Grimston explained: 'When deciding how best to divide up responsibility for the IHT bill, personal representatives must ensure they do not inadvertently put one or more beneficiaries at a disadvantage. In some cases, beneficiaries may be better off instructing the pension provider to pay a portion of the IHT due on the unspent pension.'
Income Tax Implications
If the estate holder passed away after age 75, any lump sums or withdrawals from the unspent pension taken by beneficiaries will be taxed at their marginal income tax rate. Higher and additional rate taxpayers face rates of 40% and 45% respectively. Grimston notes that instructing the pension provider to pay a portion of the IHT bill could reduce overall liability for these beneficiaries.
Administrative Challenges
Grimston emphasized the administrative difficulties: 'Managing multiple pension providers at once, getting the valuation of the unspent pension and working out the proportional share on each of those pensions is a time-consuming process. The danger here is that, keen to avoid late payment fees, many beneficiaries will rush the early stages and ask the pension provider to settle a share of the IHT owed. While this may seem sensible at first, it can ultimately leave some beneficiaries worse off in the long run.'
Strategies to Mitigate IHT
Saltus suggests that strategies such as taking tax-free cash in tranches rather than lump sums may offer IHT advantages. Other methods include giving gifts to friends and family out of excess income, putting life insurance in trust, and leaving money to charity. Grimston advises: 'While some question marks remain around how the new regime will work, the Government’s latest guidance has provided some degree of transparency. Anyone thinking of taking immediate action to reduce their liability must know what their tax rate is to withdraw from the pension, what their children’s or beneficiaries’ tax rates are, and what other assets they have.'
The government stated in November's Budget that it is 'making further reforms to taxation of income from assets and property wealth to make sure the wealthiest pay their fair share.' It added that these measures will limit the contribution asked of everyone while protecting public services, making record investment in the NHS, and cutting debt and borrowing.
