UK autumn budget 2024: major pension reforms proposed
The Labour government’s first Autumn Budget delivered on 30 October 2024, proposed a series of significant changes to pension legislation with the aim of tightening tax rules. We asked David Hogan, Director, Financial Planning at Evelyn Partners to explain how the changes are set to reshape retirement planning and estate planning for many people.
While the focus of this article is the impact on pension scheme savers, we should also spare a thought for pension administrators who, it seems, will become responsible for processing payments of inheritance tax (IHT) in future. This will be the focus of a future article in MHM’s Pensions Connections newsletter.
Inheritance tax to apply to pension death benefits
One significant change is the proposal to bring unused pension funds and death benefits within the scope of IHT from 6 April 2027. Since 2015, defined contribution (DC) pension pots and lump sum death benefits from defined benefit (DB) schemes are typically excluded from a deceased individual’s estate for IHT purposes. This has allowed many retirees to use pensions as a tax-efficient vehicle for passing on wealth.
Under the proposal, these benefits will be treated as part of the estate and taxed accordingly. The government argues this change will discourage the use of pensions as inheritance tools and encourage retirees to use their pension savings for retirement income rather than estate planning
One consequence is that pension scheme administrators will be responsible for reporting and paying any IHT due on unused pension funds and death benefits. Where there is more than one pension provider, executors for the deceased will be required to liaise with several providers to apportion the tax due.
The impact of double taxation on pensions
The pension reform proposals introduce a double taxation effect for pensioners over the age of 75, particularly in relation to pension death benefits.
- IHT on pension death benefits
Should the proposals go ahead as announced, from 6 April 2027 unused pension funds and lump sum death benefits will be included in the deceased’s estate for IHT purposes. This is a significant shift from the current rules, where such benefits are generally exempt from IHT.
For individuals who die after age 75, their pensions will be subject to IHT at 40%, assuming the estate exceeds the available IHT bands.
- Income tax on beneficiaries
In addition to IHT, if the beneficiary chooses to draw down the inherited pension rather than taking it as a lump sum, they will also be liable for income tax on the withdrawals. This is particularly relevant for deaths occurring after the age of 75, where income tax has always applied to beneficiaries, only now it comes on top of IHT.
- Effective tax rate: up to 67%
This combination of IHT and income tax on the beneficiaries could result in an effective tax rate of up to 67% on pension death benefits:
- 40% IHT on the total pension pot
- 45% income tax (for additional rate taxpayers) on the remaining 60%
Example: An unused pension fund of £100,000
- £40,000 IHT
- £27,000 (45% of the remaining £60,000) lost to income tax
- Only £33,000 is left for the beneficiary
Where the beneficiary is a basic rate (20%) taxpayer, the effective rate is 52% and for a higher rate (40%) taxpayer it is 62%. The effect of double taxation is that a very significant amount of pension wealth will be lost to tax.
Wider IHT implications
It is also important to be aware of the interaction of pensions with the wider estate. Since the introduction of pension freedoms in 2015, it is not uncommon for people to structure their finances to ensure their taxable estate of property, savings, investments and chattels remain within the available IHT allowances and not accessing pensions in order preserve the IHT benefits. Post April 2027, this form of planning will no longer be as effective.
A couple within a marriage or a civil partnership could benefit from up to £1m of IHT allowances subject to certain stipulations. Assuming their taxable estate falls within the available allowance they can leave their estate free of IHT.
Example:
A taxable estate of £1,000,000 on second death and unused pension funds valued at £400,000.
Second death occurs pre-April 2027:
- Non-pension assets valued at £1,000,000
- Available IHT exemptions £1,000,000
- No IHT liability on the taxable estate
- Pensions valued at £400,000 do not form part of the estate
- Total assets left to beneficiaries £1,400,000
Second death occurs post-April 2027:
- Non pension assets valued at £1,000,000
- Pensions assets valued at £400,000 are now part of the taxable estate
- Value of estate £1,400,000
- Available IHT exemptions £1,000,000
- Excess above exemption £400,000 taxed at 40%
- Total tax £160,000
- Estate left to beneficiaries £1,240,000
This is before we consider the potential double taxation of pension death benefits mentioned earlier.
Conclusion
By extending IHT to pension death benefits and tightening rules on overseas transfers, the government is sending a clear message that pensions are for retirement, not inheritance. While the full impact of these changes will unfold over the coming years, it is clear that the reforms increase the complexity of planning for both pensions and estate planning.
Evelyn Partners Financial Planning Limited is authorised and regulated by the Financial Conduct Authority. Advice in relation to inheritance tax planning is not regulated by the Financial Conduct Authority, however, the products used to mitigate tax may be regulated. Further details about the Group are available at: www.evelyn.com © Evelyn Partners Group Limited 2025
Back