Farewell to the Tax Loophole: Inheritance Tax on British Pensions in Focus

The British government plans to tax pension assets with inheritance tax starting from April 2027. This measure was announced by Finance Minister Rachel Reeves as a step towards closing an existing loophole. This loophole allowed pension funds to be used tax-free as a vehicle for wealth transfer between generations. According to experts, this could lead to a significant increase in the tax burden for wealthy retirees. Through this measure, the government expects to generate additional annual revenue of 1.46 billion pounds by April 2030 and anticipates that around 10,500 estates will have to pay more inheritance tax. Furthermore, beneficiaries whose retired relatives die after the age of 75 may also have to pay income tax on inherited pension benefits. Tom Selby from AJ Bell highlighted the significant tax increases for wealthy individuals aged over 75. The government voiced concerns about the use of pensions for old-age provision, especially after the abolition of the lifetime allowance in 2023, which was previously applied to pots over 1,073,100 pounds. The misuse of pensions as a tool for estate planning represents a 'curious state', as noted by the Institute for Fiscal Studies. While spouses and civil partners remain exempt from inheritance tax, experts like Mike Ambery from Standard Life foresee a fundamental change in how wealthy people manage their money in retirement. Instead of withdrawing from Individual Savings Accounts, retirees might increasingly access their pension savings to avoid a double tax burden after their death. Unmarried partners could also be particularly affected by the changes. Side effects of the tax change might also include altered saving behaviors among retirees, who would be forced to spend their savings more quickly, potentially endangering their financial security in old age. Former Pensions Minister Ros Altmann warns that many could underestimate their lifespan and therefore spend their pensions prematurely. As a result, strategies like early gifting of pension funds could be considered to avoid inheritance tax, as noted by Steve Webb, an advisor at LCP.