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Inheritance Tax (IHT) is a levy your beneficiaries might pay on the value of your estate when you die. Previously, pensions could be passed on without IHT, but in October 2024, chancellor Rachel Reeves proposed that this exemption should end from April 2027.
This could mean that your beneficiaries pay more IHT in the future. Plus, depending on how old you are when you pass away, they could face a “double tax” on your pensions. This is because they may pay IHT when inheriting the pension and could also pay Income Tax when drawing flexibly from it.
Unused pension benefits are normally exempt from Inheritance Tax, and will remain so until April 2027
When you pass away, the executor of your will must add up the total value of all taxable assets from your estate to calculate how much IHT is due, if any.
In 2024/25:
- An individual can pass on up to £325,000 without paying IHT. This is your “nil-rate band”.
- You may also benefit from up to an additional £175,000 “residence nil-rate band” when passing your main home to a direct descendant, such as a child or grandchild. If your estate is worth more than £2 million in total, your residence nil-rate band will be tapered down, and disappears completely at £2.35 million.
- If you bequeath your entire estate to a spouse or civil partner, they inherit your unused nil-rate bands. Consequently, you could pass on up to £1 million between you before IHT is due, if you benefit from the full residence nil-rate band.
- The portion of your estate that exceeds the nil-rate bands is typically taxed at 40%, unless some is ringfenced within a trust, which may mitigate IHT.
Currently, pensions are exempt from IHT.
Unfortunately, during her Budget in October of last year, chancellor Rachel Reeves proposed that the exemption for pensions should end in April 2027. As a result, your beneficiaries may pay IHT on your unused pension wealth in the future.
If you had £1 million left in your pension when you passed away, and the rest of your estate already exceeded the nil-rate bands, your beneficiaries could pay 40% IHT on your pension wealth. This could leave them with a bill of £400,000.
Your beneficiaries could pay a “double tax” on your pension if you die after 75
As well as paying IHT, whoever inherits the pension could pay Income Tax when they eventually access the funds.
If you pass away before age 75, your beneficiaries will not pay any Income Tax when accessing an inherited pension. If you are older than 75, they will pay Income Tax at their marginal rate when drawing from the pension.
This could mean that your pensions effectively face a “double tax”.
Referring to the example discussed earlier, if you had a pension pot of £1 million with IHT due on the full amount, your family could pay:
- £400,000 in IHT, leaving them with £600,000.
If you passed away after 75, your beneficiaries would then also pay Income Tax at their marginal rate on the remaining amount. If they drew the full amount, this would mean:
- A higher-rate taxpayer pays another £240,000, leaving them with £360,000 from the original pension pot of £1 million.
- An additional-rate taxpayer pays another £270,000, leaving them with just £330,000.
As such, in future, it could be more important than ever to find ways to potentially mitigate a large IHT bill for your beneficiaries.
Get in touch
If you are concerned about a potential “double tax” on your pensions, please contact your wealth planner for guidance.
Please email info@ipscap.com for more information.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, or trusts.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
