HMRC has confirmed that four inheritance tax (IHT) reliefs will be denied on assets held inside pensions from 6 April 2027, as part of a sweeping overhaul that could leave families facing an effective tax rate of up to 64 per cent on inherited pension pots. The move, which applies to unused pensions, marks the first time these funds will be pulled into the IHT net, and industry experts warn it creates a 'two-tier' system that penalises grieving families.
Which reliefs are being scrapped?
The four perks being withdrawn for pension-held assets are loss on sale relief, business property relief, agricultural property relief, and the option to pay IHT in instalments. These reliefs are commonly used on other assets to reduce tax bills or spread payments, but HMRC has confirmed they will not apply to pension funds. This means estates with significant pension wealth could face higher tax liabilities and less flexibility when settling IHT.
Rachel Vahey, head of public policy at AJ Bell, said: "Dragging unused pensions into the inheritance tax net from April 2027 was already a major blow for families, but HMRC's proposed approach risks making a bad policy even worse." She added that HMRC's justification is "hard to square" because it claims pension savers do not own the assets, yet those same assets are being included in the estate for IHT purposes.
Two-tier tax system under Labour government
The changes are being implemented under the leadership of Andy Burnham and John Healey, after Healey replaced Chancellor Rachel Reeves, who originally announced the IHT shake-up before her exit from No11. The policy is part of a broader Labour government agenda to raise revenue, but critics argue it creates an unfair double standard.
Vahey explained: "Under the plans, inheritance could be subject to a two-tier tax system, where important reliefs available on other assets are denied on assets sitting inside a pension. That means estates could face higher tax bills, extra late payment interest and less flexibility at exactly the point families are already dealing with bereavement."
Risk of double taxation on pensions
One of the most concerning aspects is the potential for pensions to be taxed twice. Vahey noted: "Worse still, pensions may be taxed twice: first as estate capital for IHT and then, where the pension saver dies aged 75 or over, as income in the hands of the beneficiary." For higher-rate taxpayers, this could result in an effective tax rate of up to 64 per cent on inherited pension assets. She stressed: "Pensions should be treated as capital or income, not both."
The double taxation risk arises because the pension fund is included in the estate for IHT, and then any withdrawals by beneficiaries are subject to income tax if the original saver died after age 75. This combined burden is significantly higher than the standard 40 per cent IHT rate, hitting wealthier families hardest.
Industry calls for simpler approach
AJ Bell and the wider pensions and financial advice industry have consistently argued for a simpler, fairer system. Vahey said: "Ideally government would go back to the drawing board and look at simpler options for taxing pensions on death. If it won't do that then, at the very least, it should treat pensions the same as other assets under the IHT system, rather than creating the double standard proposed by HMRC."
The industry has proposed alternatives such as applying a flat IHT rate to pensions or aligning treatment with other assets, but so far HMRC has not indicated any willingness to revise the plans. Families are advised to review their pension arrangements and estate planning ahead of the 2027 deadline, as the new rules will require careful consideration of who benefits from pension funds.
Vahey concluded: "AJ Bell, alongside the wider pensions and financial advice industry, has consistently argued that there are simpler, clearer, and fairer ways for the government to meet its policy and revenue-raising objectives without creating this level of complexity and distress for grieving families." The changes are set to take effect on 6 April 2027, and further guidance from HMRC is expected in the coming months.
