From April 2027, pensions will no longer sit outside the inheritance tax net: a move that could trigger one of the harshest tax pitfalls: being taxed twice on the same pot of money.
With rates potentially hitting 90%, understanding your legal and financial exposure is now essential.
Approximate Reading Time: 3 minutes
Topics Discussed:
- Legal implications of “double taxation” on pension death benefits.
- Effective legal strategies, including trusts and lifetime gifting, to shield beneficiaries from excessive tax exposure.
What the New Law Means for Pensions
From April 2027, pension pots (previously exempt from inheritance tax) will form part of the deceased’s estate for tax purposes.
This means that any unused pension funds passed on to beneficiaries could now attract inheritance tax (IHT) at 40%.
Approximately 8% of estates are expected to be affected annually, with HMRC projected to collect £1.46 billion from this change by the 2029/30 tax year.
The policy marks a substantial departure from current rules, disrupting estate plans that have long relied on pensions being tax-sheltered inheritance vehicles.
What Does “Double Tax” Really Mean?
This reform creates a precarious situation where beneficiaries might be hit by two separate tax regimes:
- Inheritance Tax (IHT): Pension pots exceeding the £325,000 nil-rate band could attract up to 40% IHT.
- Income Tax: If the deceased was aged 75 or older, withdrawals made by beneficiaries from the inherited pension may be taxed at their marginal income tax rate.
Legal Illustration:
If a £100,000 pension pot is passed on:
- £40,000 may be lost to IHT.
- The remaining £60,000, if drawn at a 45% income tax rate, could be reduced to £33,000.
- This results in an effective tax rate of 67%, and in worst-case legal scenarios, closer to 90%.
Such a tax outcome has severe consequences on wealth preservation and raises serious estate planning concerns for legal advisors.
Your Strategic Options
1. Reassess Pension Drawdown Tactics
The traditional approach of deferring pension withdrawals to preserve IHT benefits now needs reassessment.
Legal advisors should encourage clients to consider drawing down pensions earlier to avoid future tax traps, thereby reducing the size of the taxable estate.
2. Gifting During Lifetime
Utilise annual exemptions (£3,000 per individual) and Potentially Exempt Transfers (PETs) under the seven-year survival rule.
These allow clients to legally shift wealth out of their estate during their lifetime, reducing both CGT and IHT liabilities.
3. Property Downsizing
Selling larger properties and gifting or investing the proceeds can reduce both the overall estate value and potential IHT exposure.
Clients should be advised on SDLT and CGT implications where appropriate.
4. Consider Legal Structures Like Annuities
Annuities offer an efficient way to convert lump sums into guaranteed lifetime income, which isn’t typically subject to IHT.
Joint-life annuities further allow for tax-efficient spousal succession.
5. Life Insurance Held in Trust
Taking out a life policy structured within a discretionary trust can provide funds specifically to cover IHT liabilities, thus avoiding further erosion of inherited wealth.
Importantly, if written correctly, the proceeds are excluded from the taxable estate altogether.
Why Legal Planning Cannot Wait
Although the reforms come into effect in 2027, legal strategies to mitigate their effects are most effective when implemented early.
Drafting or revising wills, setting up trusts, and ensuring pension beneficiary nominations are up to date should be top of the agenda.
Moreover, policies like this are politically sensitive: future governments may reverse or extend such changes.
However, legal preparedness ensures resilience regardless of any fiscal U-turns.
Summary
With pensions set to be drawn into the inheritance tax net, the risk of double taxation is no longer theoretical: it’s legislative. For clients looking to safeguard their family’s financial future, now is the time for comprehensive legal and tax planning.
At Help Me Legal, our legal advisors are ready to help you navigate this complex intersection of tax and estate law. Let’s make your estate plan tax-resilient and legally watertight.
Contact Help Me Legal today at 01772 282768, fill in our contact form here, or reach out via our 24 hour WhatsApp at +447816848188.