Pension pots to be taxed in IHT crackdown

Pensions will be subject to inheritance tax (IHT) as part of a plan to raise more money from the tax and reduce relief options, Chancellor Rachel Reeves announced in Wednesday’s Budget.

Pensions have previously not been considered part of someone’s estate and therefore not subject to IHT. But this will change from April 2027, penalising those who have aggressively saved into pensions to cut their IHT bill. The government estimates that the change will affect about 8 per cent of estates every year. 

The IHT tax-free threshold will also remain frozen until 2030, currently set at £325,000, although increasing to £500,000 for those who leave their home to children and grandchildren. The threshold was already due to remain frozen until 2028, but the change will drag a higher number of estates above it as asset and property values increase over time. More estates will owe IHT as a result, at the standard 40 per cent rate.

Reeves said: “The government recognises people want to pass on their assets to their families, but the government is making the inheritance tax system fairer by ensuring that wealthy estates contribute more to the public finances.”

From April 2026, agricultural property relief and business property relief will also be reduced. After the first £1mn of combined business and agricultural assets, which will still be passed on tax-free, IHT will be levied at 20 per cent on the rest. A 20 per cent IHT rate will also apply on Aim shares.

Gary Smith, financial planning partner and retirement specialist at Evelyn Partners, said IHT rules on pensions meant that retirees who prioritised using other savings and assets to fund retirement now need to review their long-term plans. 

“As defined-contribution pension funds could now be subject to up to 40 per cent IHT, we will probably see greater withdrawals from pension pots.

"It’s arguable that this consolidates the two tiers of the UK pension system, as the change removes one of the few advantages defined-contribution pensions had over the gold-plated final-salary schemes that now exist largely just in the public sector,” he added.

Russell Miles, senior personal finance commentator at Charles Stanley, added that subjecting pensions to IHT would change how people plan for inheritance tax. "The advice has often been to touch your pensions as the last source of income in retirement," he said. 

"Turning pension savings into an income stream and giving gifts out of surplus income preserves the IHT benefits. Taking uncrystallised pension lump sums and gifting these to the next generation also has the potential to lift them out of the IHT trap provided you live for another seven years,” he added. No changes to gifting rules were announced. 

Pension good news

Lee Hollingworth, head of UK retirement at Franklin Templeton, said that the taxation of pension pots on death was regrettable, but not entirely surprising. 

“However, the real story for pensions lies in the fact that employer pension contributions remain exempt from national insurance contributions,” he added. This option had been floated ahead of the Budget but was then abandoned. “This is significant because any change could have led to a disincentive to employer pension saving. It is with relief that this has been retained,” Hollingworth said.

Despite speculation, no changes to tax-free cash or pension tax relief were announced either, meaning that pensions survive the Budget relatively unscathed.

Reeves also confirmed the government’s commitment to the pension triple lock, which will see the state pension increase by 4.1 per cent from April 2025.