- Unused pensions will be brought into the inheritance tax (IHT) net from 6 April 2027. However, HMRC is planning on operating a two-tier IHT regime that penalises pensions unfairly compared to other assets
- HMRC has confirmed in its ‘technical note’ that key inheritance tax reliefs available under the main estate will not apply to pensions – including loss on sale relief, business relief and agricultural relief, and the ability to pay IHT on property in instalments
- HMRC justifies its approach by arguing that the member is ‘not treated as owning the pension’s assets’, so reliefs are not allowed. However, it could be said that HMRC is already treating pensions as belonging to the member when bringing them into the IHT estate
- Pensions will already be penalised from being taxed once under IHT as estate capital, and a second time, if the person dies aged 75 or over, as income in the hands of the beneficiary
Rachel Vahey, head of public policy at AJ Bell comments:
“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.
“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.
“HMRC’s justification is hard to square. It says these reliefs should not apply because the pension saver does not own the pension assets, yet those same assets are being pulled into the saver’s estate for IHT purposes.
“The result is an unfair and unnecessarily complex system. Families could lose access to loss on sale relief, business property and agricultural property relief and the option to pay IHT in instalments on certain assets, solely because they are held within a pension.
“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, that could mean an effective tax rate of up to 64% on inherited pension assets. Pensions should be treated as capital or income, not both.
“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. As the April 2027 deadline approaches, the scale of the administrative burden these changes will create is becoming impossible to ignore.
“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.
What are the main IHT reliefs which will not apply to pensions?
- Loss on sale relief
“Loss on sale relief means executors can claim back some inheritance tax if certain assets are sold for less than they were worth when the person died. For example, if shares are valued at one price on the date of death but later sold for less, the estate may be able to use the lower sale price instead and get an IHT refund.
“However, although this IHT relief applies to qualifying investments held in an ISA tax wrapper it won’t apply those held in a pension.
- Business property relief and agricultural property relief
“These valuable reliefs reduce the taxable value of farmland or business assets by up to 100%, capped at £2.5 million, and 50% relief on anything over that amount. This allows family farms and businesses to be passed on without the owners having to sell the assets to pay IHT.
“Again, this valuable relief won’t apply to any farmland or businesses held in pensions, resulting in some executors facing higher IHT bills, and possibly considering moving such assets out of pensions before death.
- Paying IHT in instalments
“HMRC allows executors to pay IHT on certain assets, including commercial property, in up to ten equal yearly instalments. This can help estates avoid selling illiquid assets quickly, though late payment interest is usually charged on the outstanding balance.
“But if that commercial property is held with a pension, then such flexibility is not available. Instead, the executor could be looking for a quick sale so they can settle their IHT bill as speedily as possible.
Which IHT reliefs DO apply to pensions?
“Quick succession relief will apply to pension assets. This reduces the IHT due when the same assets are taxed twice within five years – for example they are taxed under a parent’s estate when passed to a child, and then under the child’s when they die, if that’s within five years.
“The IHT due will be reduced on a sliding scale depending on how long it is from the first transfer of assets between estates.
“Quick succession relief can be very valuable at bringing down IHT bills, but it can be complicated, and there are strict rules to know about and follow.
Double whammy taxation
“Under the new rules, beneficiaries could also feel the double whammy of both IHT and income tax on their inherited pensions, meaning higher-rate taxpayers facing a marginal rate of tax of at least 64%. Taxing the inherited assets as both capital and then income feels intrinsically unfair.”
Illustrative impact of IHT and income tax on a £100,000 inherited pension
