Britons risk 'death tax on pensions' as inheritance raid looms ahead of Budget

As it stands, retirement savers can withdraw a lump sum worth 25 per cent of their pot with the maximum amount being £268,275.

There is speculation this relief could be reduced or altered as part of the Budget to increase the tax liability on pension savings.

On top of this, analysts have warned that inheritance tax (IHT) could be made payable on retirement funds as Reeves attempts to generate revenue for the Treasury.

Currently, IHT is not paid on peoples' pensions as the value of the pot is not considered to be included in the value of an estate.

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Under current rules, the beneficiaries of most defined contribution pension pots pay no IHT if the owner dies before the age of 75. Despite this, there are slight changes to these rules when it comes to larger funds.

A deceased pension pot holder has what is referred to as a "lump sum and death benefit allowance" limit worth £1,073,100 which is able to be withdrawn tax free.

This amount factors previous tax-free lump sums and serious ill health lump sums that were taken while they were still alive.

However, an exemption exists when a lump sum is paid out of funds previously tested against abolished lifetime allowance before April 6, 2024.

Helen Morrisey, the head of retirement analysis at Hargreaves Lansdown, outlined why the Chancellor could likely launch a "death tax" raid on pensioners later this week.

She explained: "Changing the tax treatment of pensions on death could prove a tempting target for the Government. The current system sees pensions passed on tax free if a death occurs under the age of 75.

"Deaths over age 75 see beneficiaries pay income tax on what they receive. In most cases pensions do not attract inheritance tax.

"It’s a move that sets pensions apart from other savings vehicles and has prompted people to spend down other assets and leave their pensions to pass on to loved ones."

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However, the pension expert broke down what a potential overhaul to the pension tax system could look like.

"What such a change would look like in practice is subject to debate. Would we see IHT levied as reported or would we see a return to a separate and extra 25 per cent charge on pension assets, as was the case pre-Freedom and Choice?" Morrisey said.

"A separate charge would be a simpler option to implement. Any change would undoubtedly have a major impact on people’s behaviour and see a switch from people looking to run down their ISAs during retirement, to their pension - whether that be through gifting to loved ones or increased spending."

A UK Government spokesperson said: "We do not comment on speculation around tax changes outside of fiscal events."