News

31 Aug 2025

Who we can help: How about your family paying 67% tax your pension? Major changes in financial planning are on the horizon after changes to pension pots and inheritance tax.

In the October budget last year (2024) it was announced that pension pots (specifically personal pension amounts remaining on death) will be included in a person’s estate from April 2027. This means that anything remaining in your personal pension pot when you die may be added to the total value of your estate on death for calculation of IHT due. Remember that IHT will not be chargeable on transfer to a spouse, but will become due on the death of the second spouse or any transfer of assets to other descendants or beneficiaries. This is subject to the total estate value including pensions being over and above Nil Rate Band and Residence Nil Rate Band – which comes to a combined total of £500k per person. So the first £1m of assets for a couple is not subject to IHT.

There has also been recent clarification that personal representatives (executors of the estate), not pension administrators, will be responsible for the inclusion of pensions in the estate and resulting calculations of IHT due. Legislation is still being tabled so there may be further fine-tuning before this becomes law. But this will place an additional responsibility on personal representatives, who will now need to track down all of the pensions attributable to a person who has died. Many other details remain unclear, including how potential conflicts between the wishes stated in a will and those expressed in letters to pensions trustees, are to be resolved.

 

Example: Mrs Pear

Mrs Pear’s husband died a few years ago, and she now owns their house worth £750,000 and also some ISA investments worth £250,000, meaning their combined total value is £1m. In addition, she has a personal pension worth £400,000. Under the current rules her total estate value would be £1m, and if she dies before April 2027, there is no inheritance tax to pay on the estate. However, from April 2027, the pension value will be added to the estate, making her total estate value £1.4m, with 40% inheritance tax due on £400,000. So £160,000 of tax will be payable.

What are the wider planning impacts of this change?

Previously pension pots were outside of IHT and so they were often used by wealthier individuals as a form of estate planning because they could be transferred to descendants (or others) outside of a person’s estate. This clearly will not be viable for anyone whose remaining estate outside of their pension is already reasonably substantial – as it is likely to be for anyone with a property in the South-east that is fully paid off.

On death, a pension may now be subject to 40% IHT. If the pension-holder dies before age 75, then the beneficiaries (recipients) of the pension may draw down from the pension free of tax. However, if the pension-holder dies over age 75 then any drawdown by beneficiaries is at their marginal rate of income tax – which could be as much as 45%.

 

Example: Mr Orange

Mr Orange has diligently saved to accumulate a £1m pension pot. He also has property and other assets with a total value of £1m which use up all of Nil Rate Band and Residence Nil Rate Band for himself and his previously deceased spouse Mrs Orange.

From April 2027, Mr Orange will now have an increase in estate value from £1m to £2m.** Assuming the executors elect for the pension to pay 40% IHT on the excess value of £1m, the remaining balance of his pension would be £600,000.

Mr Orange dies later in 2027, at the age of 77. His daughter is the nominated beneficiary of his pension. She is doing well in her career and earns over £125,000 per year, meaning that her marginal income tax rate is 45%. If she were to draw down the entire pension pot, she would then suffer further taxes of 45% on the balance. From Mr Orange’s original pension value of £1m, his daughter would only receive £330,000. Effectively she will have suffered tax at a rate of 67% on the transmission of the pension pot to her.

The daughter can of course, opt to wait until her tax rate is lower and only then to draw down from the pension. However, she runs the same risk of dying with the pension as part of her estate for IHT purposes, and seeing the capital value further eroded at this point in time. For many a bird in the hand may be too valuable to ignore – especially if it could help to pay off a chunky part of a mortgage.

For a parent who, like Mr Orange, has spent decades carefully saving and investing to fund his retirement, his tragic death shortly after his 75th birthday (and after April 2027) would be a huge tax gain for the government and a significant loss of lifetime savings for his family.

 

What can be done about this?

For most retirees, aiming to die before age 75 and also before April 2027 is not an attractive prospect, however tax efficient this might currently be.

More realistically, here are a few things that are worth further discussions:

  1. Take available tax free cash from the pension
    Typically the maximum Lump Sum Allowance (the 25% tax free cash portion on commencement of a pension) is £268,275 – based on a total pension value of £1,073,100.
    While this sum will not be removed from one’s estate, at least it will have been withdrawn tax free and can then be used in various ways – although for example transferring this sum into ISA, at a rate of £20k per year, will take more than 13 years, during which time further taxes will be payable on capital gains and income from the investments.
    There is a caveat worth noting that in some specific circumstances, a larger amount of tax free cash may be available. Possibly including if you have protected allowances and / or have taken other pensions without using the tax free lump sum – e.g. with a defined benefit pension, also known as a Final Salary pension. It is worth speaking with me or another financial advice professional if this may apply to you as the details will be very specific to your individual circumstances.
  2. Change your income drawdown strategy
    A big part of retirement planning is looking at the most tax-efficient way to withdraw more income from your pension(s), where relevant utilising both spouses tax bands as much as possible. Even if income is taken at 40% income tax, this may not be as bad as suffering the same 40% tax on death – at least you get to enjoy the money! And gifts to others from regular income are currently exempt from IHT.
  3. Reduce your asset base to mitigate IHT.
    Making a gift and surviving 7 years after the gift so that there is no IHT payable is currently the most effective way to reduce the size of one’s estate. This could include gifting some of the tax free cash withdrawn from a pension.
    Another option is to sell property to reduce the size of one’s estate. For example by downsizing or renting a property instead. Potentially paying for this rent from pension income. From a lifestyle perspective, although down-sizing can be an adjustment, being a tenant can also be a sensible choice when you are no longer as young and mobile or as able to maintain and repair your property. The frictional costs of being a tenant are also potentially lower than the incremental stamp duty costs incurred each time you buy a new property.
  4. Take an annuity
    While less relevant for those who have very large pension pots, in some cases, using a pension pot to purchase an annuity income might be a sensible way to bolster your income and simultaneously reduce the size of your potential estate. However, annuity rates offered do depend on your age and expected longevity, and once done this cannot be reversed. So you are committing yourself to a long-term income stream and the associated income taxes payable, even though legislation around pensions could change again in the future.
  5. Consolidate your pensions
    A housekeeping point to bear in mind is that if you have many different pension pots, this could create a significant headache for those looking to accurately account for your pensions as part of your total estate on death. Where appropriate (and almost certainly not where a pension has unusual or safeguarded benefits attached) it may make sense to consolidate pension pots together, if you haven’t already done so.

 

Short-term Thinking in policy

Without getting too philosophical, the intersection of taxation and fairness in policy is not simple. Contributions into pensions are typically made with significant tax breaks (see our article on this here). However, pension savings can only be accessed in most cases from age 57, meaning that one is forced to lock these savings away for quite a long time. Governments have therefore struggled to incentivise long-term pension saving, without which many retirees run the risk of eventually becoming entirely dependent on state support.

Changing the rules to include pensions for IHT purposes, is not helpful as a way of demonstrating long-term policy consistency to encourage retirement saving. However, in the short-term the Chancellor has engaged something of a pincer movement: threatening retirees with the prospect of either being taxed now, as they withdraw from their pensions, or later in a double or triple whammy on their death. No doubt the idea is to prompt many people who may be caught by this change, to alter their pension income patterns, leading them to spend money which could stimulate the economy, while also paying more taxes along the way. Which no doubt was what the Chancellor had in mind, as one more way to increase the revenue into public coffers.

 

What are your retirement plans? Do you have clarity about what you need to achieve your desired retirement lifestyle? And to help others now or in the future?

 

If you’d like to discuss achieving peace of mind around your retirement, please book a free initial chat here:

https://calendly.com/duncan-bw-hoebridgewealth/30min

 

Download our free guide to retirement planning here: https://hoe-bridge-wealth.kit.com/guide-retirementplanning

 

Download our guide to estate planning and IHT here: https://hoe-bridge-wealth.kit.com/guide-estateplanning-iht

 

**The total estate value of £2m is on the cusp of tapering the Residence Nil Rate Band, which is diminished by £1 for every £2 of total estate value over £2m, until a combined estate value of £2.7m completely eradicates the Residence Nil Rate Bands for both spouses. In reality, over time most estates continue to grow so that an estate currently worth £2m would be expected to be worth more in the future. However, we need not concern ourselves overly with this here, as the numbers are intended to be illustrative.

 

NOTE: None of the above is financial or investment advice and you should speak to me or someone else professionally qualified to give you advice specifically tailored to your circumstances. 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. 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. The Financial Conduct Authority does not regulate Wills, Tax and Estate planning.