The Hidden Tax Raid on Pensions: What You Need to Know

Recent changes to inheritance tax (IHT) rules on unused pension funds have created a quiet storm, but the impact could be catastrophic for many pensioners. From 2027, unused defined contribution (DC) pension funds inherited after the age of 75 will no longer be exempt from IHT. This has profound implications for retirees and their families, especially those who rely on their pensions as a safety net for care costs and longevity risks.

This isn’t just a minor tweak; it’s a seismic shift in how pensions work, and its ramifications demand attention.

How the New Rules Work

Under current rules, pensions have been a highly tax-efficient way to save for retirement. If you didn’t use all your pension pot and passed away, the remaining funds could be passed on tax-free if you died before 75 or taxed at the beneficiary’s income tax rate if you were older.

The new rules mean that from 2027:

1. Unused pension funds will be subject to 40% IHT, even after the age of 75.
2. Beneficiaries will also pay income tax on withdrawals at their marginal rate.

This double taxation means that up to 67% of your pension pot (or higher) could go to HMRC, leaving far less for your loved ones.

A New Financial Dilemma for Pensioners

These changes create a significant challenge for retirees who have saved diligently in their pensions to cover future care costs or outlive their savings. Under the old rules, it made sense to preserve your pension funds, spending other assets first.

Now, however, the reverse is true. To avoid punitive taxes:

• Retirees may feel pressured to prioritise spending their pension pots over other assets, accelerating withdrawals and incurring higher marginal tax rates.
• Rapid decumulation could push some retirees into higher tax bands, even losing personal allowances and paying additional taxes.

A Tax Raid in Disguise

This change amounts to a tax raid on pensioners, particularly those with moderate to large pots who may have assumed their savings would cover a long retirement and support their families if they passed away earlier than expected.

Imagine a retiree with a ￡500,000 pension pot who planned to withdraw cautiously over their retirement years:

• Accelerated withdrawals to minimise IHT could mean paying 40% income tax instead of 20%.
• After death, remaining funds would still face 40% IHT.

This means your carefully saved pension could be taxed at a higher rate both during your lifetime and after your death, leaving significantly less for you and your family.

Broader Implications

This policy doesn’t just affect individual retirees; it could undermine the pension system itself:

1. Discouraging long-term savings: With reduced incentives to save in pensions, many may opt for other investment vehicles, reducing funds available for long-term growth in the UK economy.
2. More retirees dependent on state benefits: As pension pots are depleted more rapidly, retirees may exhaust their savings, placing greater strain on public finances.
3. Complexity and delays: Calculating tax liabilities on inherited pensions will become more administratively burdensome, causing delays in payouts when families need funds most.

What Can You Do?

While this new reality is concerning, there are steps you can take to protect your wealth and secure your financial future:

1. Review your retirement plan: Work with a financial planner to explore tax-efficient strategies for decumulating your assets.
2. Consider alternative savings: ISAs, for example, remain free of income tax and capital gains on drawdown, and can complement your pension savings.
3. Stay informed: Respond to the government’s consultation (closing in March 2025) and make your voice heard. Policy changes are still subject to revision, and collective action matters.

Let’s Talk Solutions

At the Academy of Life Planning, we’re here to guide you through these changes with clarity and confidence. We specialise in helping people like you adapt to shifting financial landscapes while protecting your long-term goals.

If you’re feeling unsure about how to navigate these changes, book a free discovery session today. Together, we’ll create a plan to maximise your financial security and ensure your hard-earned savings work for you—not the taxman.

Let’s secure your financial future, one step at a time.