From April 2027 inherited pension pots will be subject to inheritance tax (IHT), Chancellor Rachel Reeves announced today in her Budget.

The decision removes the protection of unused pensions from IHT and will potentially produce more revenue for the Treasury

The Treasury said the decision, “removes a distortion which has led to pensions being used as a tax planning vehicle to transfer wealth rather than their original purpose to fund retirement.”

The Treasury said that Inheritance tax thresholds will be fixed at their current levels for a further two years until April 2030 and more than 90% of estates each year will not pay inheritance tax.

The move to include pensions in the IHT net was greeted with disappointment by many experts.

Jon Greer, head of retirement policy at Quilter, said: “The changes to the IHT efficiency of pension will come as a blow to many. Previously pensions could be passed on free of inheritance tax (IHT), allowing many people to use pensions as a tax-efficient vehicle to pass on wealth to their heirs.

“The tax treatment of funds remaining in a pension at death were very favourable. If an individual died before age 75 the funds were not subject to income tax if paid as a lump sum within the deceased’s available lump sum and death benefit allowance. In addition, any funds remaining in a pension at death regardless of age are not subject to inheritance tax.

“The removal of the IHT exemption will result in a double tax hit for beneficiaries, although the normal exemption for spouses and civil partners will continue to apply. Not only is the pension subject to income tax when drawn (if the deceased is over 75), but it also now falls within the scope of inheritance tax. For families inheriting larger pension pots, this will lead to significant tax liabilities, depending on the recipient’s income tax bracket.”

Helen Morrissey, head of retirement analysis, Hargreaves Lansdown, said the move could well be complex and need changes to trust law.

She said: “The generous treatment of pension death benefits has long been considered low hanging fruit for a government in search of cash. It’s a stance that has set it apart from other savings vehicles with the position where a death occurs pre age 75 particularly generous. It’s led to criticism that people were leaving their pensions untouched so they could be passed down the generations in a tax efficient manner rather than being used to provide an income in retirement.

“Today that fruit has been plucked as pensions will now be made subject to inheritance tax. It’s a move that could prove complex and will need changes to trust law to make workable. A much easier solution would have been a return of the so-called “death tax” that existed pre-Freedom and Choice and it is important that the industry engages with government during the consultation process to make sure unnecessary complication is not introduced.”

Inheritance tax (IHT) receipts are expected to raise £8.3 billion in 2024-25, a 10.7% increase from last year, according to platform Nucleus.  

Andrew Tully, technical services director at Nucleus, said other tax measures such as the freeze to the IHT nil rate band at £325,000 and the residence nil rate band at £175,000, as well as changes to agricultural property relief, could spur a big increase in IHT receipts for the Treasury over the next few years.

He said: “These measures, taken together with the inclusion of pension death benefits within estates, will see a massive increase in IHT receipts over the next few years almost doubling to nearly £14bn.

“Advisers can help clients mitigate these taxes by reviewing current underlying investments within trusts as well as setting up new trusts, making use of gift allowances and spousal exemption to pass on wealth to family in a tax efficient way.”