Pension rule changes due to come into effect in just months risk grieving families being clobbered with a massive tax hit.
Calculations from UK insurance company NFU Mutual suggest tax changes mean some families losing as much as 91 per cent of inherited pensions to the taxman.
Chartered financial planner Sean McCann has warned the changes risk a “triple tax blow” for some Brits.
Inheritance tax is charged at a rate of up to 40 per cent on the value of an estate above the £325,000 tax-free allowance everyone is entitled to.
Currently, when someone in the UK dies their beneficiaries do not pay Inheritance Tax on withdrawing unspent pension money.
Under plans first unveiled in the October 2024 Budget by the then-Chancellor Rachel Reeves, this will change next year.
From April 6 2027, unspent pension pots will be included in the Government’s Inheritance Tax calculation.
A form of tax is already paid on passed down pensions from those who die over the age of 75.
Income tax is paid at a marginal rate of 20 per cent, 40 per cent or 45 per cent on pensions inherited from someone who dies after the age of 75.
It means some Brits risk a double taxation of both inheritance tax and income tax.
Further still, a third taxation bill risks hitting those with larger estates.
On top of the £325,000 inheritance tax-free threshold, a Residence Nil Rate Band worth up to £175,000 is applied for a deceased’s primary residence if it is passed on to direct descendants. The nil rate band can be doubled for married couples.
The tax free amount is gradually removed when an estate is worth more than £2million, dropping by £1 for every £2 above the cap.
The calculation means once an estate reaches a value of £2.35million, the Residence Nil Rate Band is wiped out completely.
When undrawn pensions are included in the total sum from next year, the number of estates which surpass the £2.35million is set to drastically increase and wipe out the Residence Nil Rate Band altogether.
Under this scenario, families inheriting from someone who dies after the age of 75 and paying income tax of 45 percent face an effective tax rate of 91 per cent on the pension pot.
McCann from NFU Mutual said: “The changes from April will mean some families will be hit with a triple tax blow, through a combination of inheritance tax on the pension, loss of the tax break on the family home and additional income tax if their loved one dies after age 75.
“There are steps you can take to mitigate the impact, including ensuring you take your tax-free lump sum before age 75, while it may still be subject to inheritance tax it will avoid an additional income tax charge.
“We expect to see more people taking regular income from their pensions, making use of the unlimited ‘gifts from normal expenditure’ exemption.
“This allows you to give regular gifts out of income, which provided they don’t impact your normal standard of living are immediately exempt from inheritance tax regardless of whether you survive seven years.’’
He added: “Before deciding to make big changes, it’s important to take advice to ensure that in a rush to avoid the worst of April’s tax changes you don’t compromise your future financial security.”
Official statistics indicate the median age of death in England and Wales is between 81 and 82 years old for men, and 85 and a half years old for women.
But Government officials point out the estates of most people who die do not cross the threshold of the tax-free allowance, meaning many Brits will still not be hit by the changes.
A Treasury spokesperson said: “Where inheritance tax is paid on pension benefits, beneficiaries are not taxed twice on the same funds.
“More than 90 per cent of estates each year will continue to pay no inheritance tax after these changes.”
