Revolution of the Pension System: United Kingdom Rethinks Inheritance Tax Regulations

Financial advisors in the United Kingdom are under pressure to adjust their retirement planning strategies after Rachel Reeves announced a fundamental change in the taxation of pensions in the latest budget. Starting April 2027, pension plans will fall under the scope of inheritance tax, potentially having significant impacts on wealth planning. Since the 'Pension Freedom' reforms in 2015, it has been common practice to draw down pensions as a last resort to maximize their tax-free benefits. However, this practice might soon become obsolete. The finance minister has announced plans to close the existing tax loophole that allowed pension funds to be exempt from inheritance tax, thereby enabling wealth transfers across generations. Under the new regulations, heirs of pensions could face double taxation starting from the age of 75 of the saver. In addition to the 40% inheritance tax, income tax must be paid on the pension, depending on the heir's respective tax rate. This could lead to a total tax burden of up to 67%. The news hits especially hard for those who, in recent years, moved from defined benefit pension programs to benefit from the inheritance tax advantages of defined contribution schemes. Tom McPhail from the consultancy The Lang Cat emphasized that many might be 'quite disappointed' with Reeves' announcements. Nonetheless, the transfer of pensions to spouses or registered civil partners remains exempt from inheritance tax, which might lead to increased marriages among unmarried couples. Additionally, more Britons might spend or gift their pension savings to avoid double taxation upon death. In light of the forthcoming changes, Mike Ambery from Standard Life anticipates an increase in the demand for annuities, as they offer guaranteed income and thus become an attractive option to maximize the value of wealth over a lifetime.