Most retirees would rather spend their pension savings than give them to the taxman after Chancellor Rachel Reeves tinkered with longstanding tax rules.
Financial advisers report that a pension withdrawal bonanza is underway since Reeves changed the rules in her Autumn Budget.
The rush was triggered by her decision to abolish the current IHT exemption starting from April 2027, which has excluded unspent pension savings from inheritance tax.
The new rules will put families and loved ones who inherit pension cash at a disadvantage, and are likely one of the measures Reeves has announced that will raise the most tax.
How The New IHT Rules Work
Whether someone inheriting pension cash pays tax now depends on three factors:
- The type of pension
- The saver’s age when they died
- The type of payment received
| Payment | Pot | Saver’s age at death | Expected tax |
| Most lump sums | Defined contribution or defined benefit | Under 75 | Tax-free unless the lump sum is above the pension pot owner’s lump sum and death benefit allowance |
| Most lump sums | Defined contribution or defined benefit | 75 or over | Income Tax deducted by provider |
| Trivial commutation lump sums, ie pots of less than £30,000 | Defined contribution or defined benefit | Any age | Income Tax deducted by provider |
| Annuity or money from a new drawdown fund (set up or converted and first accessed from April 6, 2015) | Defined contribution | Under 75 | No tax |
| Money from an old drawdown fund (a ‘capped’ fund or a fund first accessed before April 6, 2015) | Defined contribution | Under 75 | Income Tax deducted by provider |
| Annuity or money from a drawdown fund | Defined contribution | 75 or over | Income Tax deducted by provider |
| Pension provided by the scheme | Defined contribution or defined benefit | Any age | Income Tax deducted by provider |
Source: HMRC
Defined contribution pensions derive their value from the size of the fund. They include expat offshore pensions, such as those in the Qualifying Recognised Offshore Pension Scheme (QROPS) and self-invested personal pensions (SIPPs).
Defined benefit pensions are typically based on length of service with an employer and the saver’s final salary on retirement.
Pension death benefits paid to a UK-domiciled spouse or civil partner will remain exempt from IHT. Otherwise, pension death benefits will be included for IHT.
The implication for beneficiaries inheriting pension death benefits is that the money is liable to both IHT and income tax. For pension savers aged 75 or older, this could mean that a beneficiary pays up to 67 per cent tax on a pension inheritance.
Save Tax By GIfting Before You Die
The tax change has thrown financial advice into reverse – instead of protecting pension savings, consider:
Spend more in retirement
Spending reduces net worth and IHT in a single stroke
Take out an equity release mortgage
Taking out an equity release mortgage gives more money to spend now, while the debt reduces the value of an estate pro rata.
Gift pension cash sooner
If the pension saver gifts cash, taper relief reduces IHT if the gift was made between three and seven years before death.
| Years between gift and death | Rate of tax on the gift |
| 3 to 4 years | 32% |
| 4 to 5 years | 24% |
| 5 to 6 years | 16% |
| 6 to 7 years | 8% |
| 7 or more | 0% |
Source: HMRC
Buy life insurance
Cover the IHT bill on death with a life insurance policy that covers the potential cost. If the policy is in trust, the cash remains outside the estate for IHT purposes.
Ongoing IHT allowances
IHT is a complicated tax which comes with many reliefs and allowances. Many are available each financial year., such as a £3,000 yearly gift, as well as multiple gifts of up to £250 to whomever you choose, and wedding gifts, including up to £5,000 to a child, up to £2,500 to a grandchild, or £1,000 to another relative or loved one.
Bear in mind that cash gifts must come from income without impacting the donor’s standard of living.
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