In her first Budget the Chancellor Rachel Reeves has confirmed that pensions will be included within the value of estates for inheritance tax purposes.
This change will be effective from April 2027 — and comes as part of a package of tax changes designed to raise £40bn for the government.
When it comes to IHT changes Reeves also confirmed that the main nil-rate band for IHT (at £325,000), will remain frozen until 2030, two years further than the freeze set out by the previous Conservative government.
Reeves also left untouched the additional property threshold that allows people to effectively pass on £1m to children or grandchildren if this includes the family home.
Currently, pensions are outside the IHT net. This means that people can pass on DC pension funds tax-free if they die before they reach the age of 75. After this there is no IHT to pay, but beneficiaries will normally pay income tax at their marginal rate on funds taken out of the pension plan.
Now the value of the pensions will be added to other assets, and if the total is more than £325,000 then IHT at 40 per cent will be levied on the excess.
This move affects DC pensions, rather than DB schemes, which ordinarily can’t be passed on, beyond paying a reduced pension to a spouse.
Announcing the change Reeves said there was a need to include pensions within IHT, particularly since the lifetime allowance on pension savings has been removed.
Standard Life retirement savings director Mike Ambery says: “It’s perhaps no surprise that the Government has decided to bring pensions into scope for inheritance tax as their exemption was little-known to the public.”
He adds that this change now represents a fundamental shift to how wealthier individuals think about accessing their money in retirement. “At present it makes more sense to access Isas and other forms of saving before touching pensions. In time we’re likely to see more pensions, accessed earlier to prevent them from becoming part of people’s IHT bill at a later date.”
He adds: “The end result of this change is that many more people will now be brought into scope for IHT. While there could be some benefit to the Treasury, pensions are a long-term investment and it’s vital that large-scale changes to how they are taxed are well managed to avoid any risk of undermining confidence in pensions and scaring people from engaging with their retirement savings.”
Hargreaves Lansdown head of retirement analysis Helen Morrissey says: “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.”
She adds: “It’s a decision that will upturn many people’s plans as we will see many more people being dragged into paying inheritance tax because their DC pension is now counted as part of their estate. It’s an issue that will not be felt by those with defined benefit pensions as these cannot usually be passed on.
“We will see a flurry of people revisiting their retirement finances. The likelihood is we will see people looking to gift more money to loved ones while they are still alive – for instance money to help people get on the housing ladder. They will also look to spend down their pensions as retirement income rather than leave them untouched, a move which could keep the rest of someone’s estate below the IHT threshold. We may also see an increased interest in annuities as people look to secure a guaranteed income while also keeping their estate below the inheritance tax threshold.”