Families could be forced to pay as much as a 70.5% tax rate on unused pension funds owing to changes to inheritance tax (IHT) rules, according to Andrew Marr, managing partner at tax consultancy Forbes Dawson.
The situation facing advisers with clients that may pass on pension pots has been brought about by Chancellor Rachel Reeves’ (pictured) recent Budget.
Pensions will be brought into the scope of IHT and become subject to a 40% tax rate from April 2027. This initial hit will add to the income tax the bereaved relatives would have to pay if they draw from the pension.
“Currently, when an individual aged 75 or over dies, although there is no IHT in respect of their pension fund, there will be income tax at the beneficiaries’ marginal rates when benefits are withdrawn,” Marr said.
See also: Autumn Budget 2024: Chancellor extends IHT threshold freeze to 2030
“I, therefore, concluded that HMRC would take a 40% tax payment immediately and leave beneficiaries with the remaining 60%. That may have been fair. It is now clear that what was actually announced was a tax of up to 70.5% on unused pension funds.”
Marr noted that while we have seen many tax measures introduced over the years, the impact of this one will be “massive” on some families and smacks of “retrospective taxation”.
With the rules not set to kick-in until 6 April 2027, they will have the ‘distasteful impact’ of elderly people becoming aware that dying after 5 April 2027 will have significant negative financial implications for the beneficiaries of their estates, Marr added.
See also: Autumn Budget 2024: Capital gains tax hiked to 24%
“As there is a consultation period before any legislation is drafted, perhaps there is a small chance of a government U-turn here before these rules are enacted,” he added.
“In the meantime, this really does tip the balance on the decision of whether 25% tax free lump sums should be withdrawn from pensions.
“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.”
