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A decision by Rachel Reeves to make pension pots subject to inheritance will see the bereaved losing as much as 70.5 per cent of the nest egg. Historically, people could pass on any cash left in their pension pot free of inheritance tax if they died before the age of 75.
However, changes announced the Budget are sweeping away this exemption leaving people mourning a loved one many thousands of pounds out of pocket. Once the change comes into effect in 2027 the money in the pension pot will become liable for inheritance tax at a rate of 40 percent.
However, the tax grab goes further because the recipient will then be taxed on anything they receive at their normal income tax rate which could be 20 percent, 40 percent or 45 percent.
The net effect of these combined taxes could mean that the government takes as much as £70,500 out of each £100,000 left in a pension pot to their children.
Many families had counted on leaving their pension pots to loved ones as a way of protecting and passing on their wealth, however these plans have now been thrown up in the air by the decisions made in the budget.
Now that this option has been removed, older Britons will need to rethink how to finance their retirement.
Many may choose to take money out of their pension pots early to give away to their adult children perhaps to help them get a foot on the property ladder, however they will lose a substantial proportion of any withdrawals to the taxman.
Others are seeking advice on whether wealth can be protected from the government by putting cash and assets into a trust, while some are expected to take out insurance policies that a specifically designed to cover inheritance bills. However, these policies can cost more than £200 a month.
The Treasury said it expects the change on inheritance tax (IHT) to affect around 8 percent of estates each year, and raise £640million in 2027/28, £1.34billion the following year, and £1.46billion by the third year the new rules are in place.
Andrew Marr, managing partner at tax consultancy Forbes Dawson, said: “’This measure is only set to come in from 6 April 2027 and the impact is huge. It seems that beneficiaries will still have to pay income tax when they take out benefits.”
He said that a recipient who currently pays a 45 per cent tax rate on their income could effectively lose 67 percent of a pension pot inheritance. However, he said other small print in tax rules mean the effective tax rate can be as high as 70.5 per cent.
He added: “For many people who feel like they have done the responsible thing by paying into pension schemes this will be a kick in the teeth.”
He said the changes mean that people should make use of the 25 percent tax free lump sum they can take out of a pension pot, rather than leaving the money in place at risk of being taxed on death.
“This really does tip the balance on the decision of whether 25 percent tax free lump sums should be withdrawn from pensions,” he said.
“Anybody who thinks that they will leave unused pension funds should consider taking out the lump sum and gifting it. Even if they do not gift it, their beneficiaries would be saved a double layer of tax in the scheme when they die.”
Jon Greer, head of retirement policy at Quilter, says: ‘The removal of the inheritance tax exemption will result in a double tax hit for beneficiaries, although the normal exemption for spouses and civil partners will continue to apply.
“For families inheriting larger pension pots, this will lead to significant tax liabilities, depending on the recipient’s income tax bracket.”
Jason Hollands, managing director of Evelyn Partners, told This is Money: “With pension assets having overtaken property as the largest source of private wealth in the UK in recent years, this measure is certain to draw many more estates into the web of inheritance tax.
“This development will require a major rethink of financial plans for some people, who had been prioritising their pension pots as a means of passing wealth on to their children and grandchildren.”
Craig Rickman, pensions expert at Interactive Investor, said: “’Reeves’s move to scrap the inheritance tax exemption on unspent pension savings is bold, and will be a blow to savers who have beefed up their retirement pots to harness the estate-planning perks.
“This will reduce the allure of cascading pension pots down generations.”
Julie Hammerton, a partner at Hymans Robertson, said: “These changes will have a big bearing on how people approach passing on wealth to their loved ones.
“With pensions coming into the inheritance tax regime, it’s more likely that they will be accessed for an income in retirement, rather than a means through which wealth can be passed on to future generations.
“From a financial planning perspective, the order in which people access their long term savings will likely change. This sequencing is something that those in the fortunate position to have savings will need to get their heads around.
“The positive is that pensions remain a very effective means through which to save for the future. We shouldn’t lose sight of that.”