Reeves' inherited pension changes mean families face 'double tax' hit

The Chancellor aims to remove a “distortion” which she says has led to pensions being used for tax planning purposes, rather than to fund retirement.

It’ll be a blow to many - specifically high-net-worth individuals - as pensions could previously be used as a tax-efficient vehicle to pass on wealth to their heirs.

“The tax treatment of funds remaining in a pension at death were very favourable,” Jon Greer, head of retirement policy at Quilter, explains.

“If an individual died before age 75 the funds were not subject to income tax if paid as a lump sum within the deceased’s available lump sum and death benefit allowance. In addition, any funds remaining in a pension at death regardless of age are not subject to inheritance tax.”

This rule change will result in a “double tax hit” for beneficiaries, the retirement expert warned, although the normal exemption for spouses and civil partners will continue to apply.

“Not only is the pension subject to income tax when drawn (if the deceased is over 75), but it also now falls within the scope of inheritance tax.

"For families inheriting larger pension pots, this will lead to significant tax liabilities, depending on the recipient’s income tax bracket.”

While the decision will help boost Treasury coffers, it also marks the Government attempting to return pensions to solely a retirement planning vehicle, rather than inheritance tax planning, Greer suggests.

While inheritance tax predominantly has historically affected the wealthiest, more and more families face being affected as thresholds remain frozen and house prices rise.

Adding pensions to estates could substantially increase the number of estates which become subject to inheritance tax.

“For many individuals, their pension can be one of their most – if not the most – valuable asset they own,” Steven Cameron, Pensions Director at Aegon, explained.

Even more families are set to be affected by the levy in the coming years, as Reeves has extended the previous Conservative Government's freeze to IHT thresholds, for a further two years.

The standard inheritance threshold will remain at £325,000 until 2030. The IHT-free limit rises to £500,000 if the benefactor gives their home to their children or grandchildren. Married couples and civil partners could pass on up to £1million free from inheritance tax.

More and more people face being dragged into paying inheritance tax due to this freeze – a tax-raising measure known as fiscal drag - as prices rise but the thresholds do not.

Reeves says more than 90 per cent of estates each year won’t pay inheritance tax.

This in itself indicates the impact of fiscal drag and measures announced today as the most recent figures show that just over four per cent pay inheritance tax.

READ MORE ON 2024 AUTUMN BUDGET:

• Rachel Reeves announces 'hidden pension benefit' which will boost retirement income for millions
• Chancellor confirms increase in employer National Insurance contributions
• Rachel Reeves confirms a state pension increase of 4.1%

It’s a major change, and experts are warning it could have an impact on retirement planning.

“While everyone hopes to live many years into retirement, not all do so. Those who die early in retirement are more likely to leave a substantial pension pot which could now be brought within the IHT regime,” Cameron said.

“But taking too much out of their pension too early risks running out of money later in life.

“While the Government has set out its intent, we hope there will now be full consultation around the detailed approach, which avoids unintended changes in saver behaviour.”