Retirees across the UK are confronting a potential tax rate of up to 87 percent on their pension savings due to a substantial overhaul of inheritance rules planned by the government.
The Double Tax Hit Explained
Chancellor Rachel Reeves is spearheading reforms that will, from April 2027, make pension pots liable for Inheritance Tax (IHT). Currently, estates enjoy a tax-free threshold of £325,000. Under the new rules, any pension assets passed to beneficiaries that exceed this allowance will be subject to a standard 40 percent inheritance tax levy.
This change creates a significant double taxation effect for many families. For pensioners who die after the age of 75, their beneficiaries must already pay income tax on any withdrawals from the inherited pension at their personal income tax rate. This rate can be as high as 45 percent for additional-rate taxpayers.
How the 87% Tax Rate Adds Up
The combination of these two taxes can consume a massive portion of the pension's value. When the 40 percent IHT is applied to the pension pot, and the beneficiary then pays 45 percent income tax on the remainder, the effective total tax rate can reach a staggering 67 percent. In some complex scenarios, the total tax burden can even climb to approximately 87 percent of the original pension value.
Jonathan Watts-Lay, a director at financial wellbeing firm WEALTH at work, issued a stark warning: "The introduction of IHT on pensions could result in substantial tax charges for some. Those most likely to be affected are individuals with larger pension pots, especially if those savings were intended to be passed on to family."
Reversing Financial Planning Advice
This policy shift turns conventional financial wisdom on its head. Mr Watts-Lay advised that people will need to review their individual circumstances thoroughly. "From an IHT perspective, it could now be better to spend pension savings first and preserve other assets for later on. This is the opposite approach to what has previously been the case," he explained.
He also recommended that individuals "speak to your employer to find out what support they provide to help staff improve their finances."
Meanwhile, Chancellor Rachel Reeves has defended the government's overall economic strategy, stating: "Under this Government, we have seen five interest rate cuts that have helped bring down costs for families and businesses... At the Budget later this month I will take the fair choices that are necessary to build the strong foundations for our economy."
