Families could face a tax hit of up to 70.5% on unused pension funds following changes announced in Rachel Reeves’s Autumn Budget, new calculations show.
Set to take effect on April 6, 2027, the Chancellor’s proposed policy would apply the 40% inheritance tax (IHT) rate on pension funds left unused at the time of death, with beneficiaries then also paying income tax on any withdrawals.
These combined taxes could amount up to a staggering 70.5% loss, a tax expert has warned, leaving a lasting impact on families relying on pensions as part of their estate planning.
Andrew Marr, managing partner at tax consultancy Forbes Dawson said: “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IHT in respect of their pension fund, there will be income tax at the beneficiaries’ marginal rates when benefits are withdrawn.
“Under proposals to take place from 6 April 2027, after the initial 40% tax hit, beneficiaries will still be subject to income tax at their marginal tax rates on anything further that they withdraw.”
Forbes Dawson used an example of a £4million pension fund to demonstrate the financial impact of this new policy.
If a pension fund worth £4million is inherited by a beneficiary with a 45% marginal tax rate, the new rules would apply an initial 40% IHT, reducing the fund to £2.4million.
The remaining amount would then be taxed again at 45% income tax upon withdrawal, leaving the beneficiary with just £1.32million out of the original £4million.
Additionally, the rules reduce the use of inheritance tax allowances, pushing the effective tax rate on the total estate value up to 70.5%.
These changes have already sparked criticism as many older individuals planned their pensions with assumptions about IHT exemptions.
Mr Marr said: “We have seen many tax measures introduced over the years, but for certain families, the impact of this one is massive and does smack of retrospective taxation.
“I use the word ‘retrospective’ because the individuals involved have reasonably believed that pension funds would be outside the scope of IHT and have often made contributions with IHT protection being a consideration.”
Mr Marr highlighted that, as this legislation is due to come into force in 2027, it could raise difficult questions for families looking to manage their finances effectively.
With a consultation period ahead, there remains a small chance of revision, but for now, Mr Marr suggests families carefully consider their estate planning strategies.
