Closure of UK inheritance tax ‘loophole’ to hit estates of wealthy pensioners

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Bringing pensions within inheritance tax from April 2027 will result in a “massive increase” on the tax bill for the estates of wealthy UK pensioners, according to pension experts.

In the Budget, chancellor Rachel Reeves announced that she would remove a “loophole” that left pension funds exempt from inheritance tax and increasingly allowed them to be used as intergenerational wealth transfer vehicles. 

The government estimates the move will raise £1.46bn a year by April 2030 and result in about 10,500 more estates paying inheritance tax than would otherwise have been the case. 

Beneficiaries may also have to pay income tax on the pension proceeds even after inheritance tax has been deducted, if the pensioner dies after they turn 75. 

“It’s going to be a massive increase some wealthier people have to pay over the age of 75,” said Tom Selby, director of public policy at AJ Bell.  

The use of pensions for retirement planning became a particular concern among government officials after the lifetime allowance — which had been charged on pots over £1,073,100 — was abolished in 2023. 

While the beneficiaries of inherited pensions already have to pay tax on the income from them if the deceased died after their 75th birthday, death before that date allows most schemes to be inherited free of all tax.

The Institute for Fiscal Studies think-tank said this resulted in a “bizarre situation” where pensions were treated more favourably by the tax system as a vehicle for bequests than as a retirement income product.

More and more people had also been expected to exploit the loophole in coming years as defined contribution pension pots grew following reforms in 2015 that gave savers more choice over what to do with their pensions.

Pensions will still pass to spouse and civil partners without incurring an inheritance tax charge.

Mike Ambery, retirement savings director at Standard Life, said the change would result in a “fundamental shift” in how wealthier individuals think about accessing their money in retirement.

Experts said people were likely to start drawing down their pension savings in retirement instead of money saved in their individual savings account, to avoid a double tax hit for beneficiaries of both inheritance tax and income tax if they die after the age of 75.

“Carefully thought through implementation and clarity will be key, perhaps most prominently in the case of unmarried partners who could be at a disadvantage,” he said.

Some savers said the tax charge would be so large that it no longer made sense for them to work. 

Ian Chapman, a 57-year-old accountant from Greater Manchester with a six-figure pension pot, said “this change means realistically it’s not worth working for me — I’m going to pack up”.

“A lot of people in middle-income situations like mine will now be in inheritance tax — it’s a real shame,” he added. 

Experts warn the move could also mean pensioners will be encouraged to spend their pensions while they are still relatively young, leaving much less to live on if they survive to older age.

“Most people underestimate their life expectancy, so they are likely to have spent their pension well before they reach their much later years,” said former pensions minister Ros Altmann, adding they would potentially have “less to live on than they otherwise would and less money to spend on elderly care”.

Steve Webb, a consultant at LCP and a former pensions minister, said people might start taking money out of their pensions and gifting it now, in the hope of living for another seven years and avoiding inheritance tax.