The UK government’s decision to bring unused pension funds into inheritance tax (IHT) calculations from April 2027 is poised to significantly increase tax bills for many families, particularly those with moderately valued estates. Chancellor Rachel Reeves’s Autumn Budget announcement marks a departure from the longstanding exemption that allowed pension pots to pass on free of IHT, aligning pensions with property and investments for tax purposes. This shift could lead to families facing substantial liabilities; for instance, a report by Quilter highlights that a single homeowner in England with a modest property valued around £290,395 and a pension pot of £415,000 could incur an IHT bill exceeding £82,000. In London, where property values are higher, the bill could climb to nearly £192,254 for an average home combined with a similar pension pot.

Experts have expressed concern over the implications of this policy change. Jon Greer, head of retirement policy at Quilter, described the move as “optically terrible” for the government, especially as it taxes pensions that the deceased might never have accessed due to dying before reaching minimum pension age. He also highlighted the particular hardship for cohabiting couples who lack the spousal reliefs and tax allowances granted to married couples, potentially facing six-figure IHT bills amid bereavement. Greer urged policymakers to consider transitional reliefs or carve-outs, especially where young children are affected, warning that without such measures, families could face unnecessary financial distress without generating meaningful additional tax revenue.

The government defends the reforms by stating they intend to encourage pensions savings for their primary goal—funding retirement rather than enabling tax-efficient wealth transfer. A Treasury spokesperson emphasised that more than 90% of estates will remain unaffected by IHT under the current rules and upcoming changes, asserting the policy will close loopholes that have allowed pensions to be used as vehicles for passing on wealth tax-free.

Previously, most pension schemes operated under discretionary terms, causing unused pension funds to be excluded from the deceased’s estate for IHT calculations. This led to pensions being treated differently from other inherited assets such as property or investments. The new rules aim to standardise tax treatment across asset classes to build a fairer system and discourage tax planning strategies that exploit pensions as a means of wealth preservation beyond death.

There are, however, exemptions within the reform legislation. Death in service benefits, whether payable from discretionary or non-discretionary pension schemes, will remain exempt from IHT. Yet, all other unused pension funds and death benefits will be included in the estate, making personal representatives legally responsible for reporting and paying IHT on these amounts from 2027.

Financial advisers and estate planners are already urging individuals to review their arrangements in light of these upcoming changes. The expected tax charge—up to 40% above the nil-rate band—could substantially reduce the inheritance passed on to beneficiaries. Some suggest early planning and considering alternative inheritance strategies to mitigate the impact, although the details on enforcement and operational aspects of the new rules are still being finalised.

Overall, the reform signals a significant alteration in the UK inheritance tax landscape, with notable financial consequences for homeowners with pension savings. While it aims to curb perceived tax avoidance and create parity among asset classes, the policy has drawn criticism for potentially imposing burdensome taxes on grieving families, particularly those without formal marital status or spousal protections. The debate continues as stakeholders call for clarity and measures to cushion the most vulnerable from the unintended fallout of this policy shift.

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Source: Noah Wire Services