Warnings for Retirement Savings and Inheritance in 2027
Inheritance Tax Overhaul: Strategies to Safeguard Your Pension from Rachel Reeves' Proposed Changes
Got a hefty pension savings nest egg to leave for your loved ones when you retire and eventually pass away? Well, brace yourself as up to 87% of it could be gobbled up in taxes once new inheritance tax regulations kick in starting 2027—that's right, we crunched the numbers with our latest calculations.
Currently, pensions sit pretty as they are exempt from inheritance tax, making them a popular route for passing on wealth to the next generation. Meanwhile, all other assets require 40% inheritance tax upon exceeding the allowances.
However, the landscape changes starting April 2027 when pensions are set to be part of your overall estate for inheritance tax calculations. This shift happens due to changes announced by Chancellor Rachel Reeves in her Autumn Budget last year.
But there are overlooked loopholes that can cause pensions to be taxed at a whopping 87% rate. Here's why this can happen, and ways you can protect yourself.
High Taxes for Inherited Pensions
Everyone starts off with two key allowances allowing them to pass on a portion of their assets tax-free from inheritance tax.
First, the nil-rate band permit passing on up to £650,000 tax-free for married or civil partners. Followed by the residential nil-rate band, which allows the tax-free passing of a home worth up to £1 million to direct descendants such as children.
However, if your estate exceeds £2 million, you'll lose these tax-free allowances gradually. For example, you lose some or all of the residential nil-rate band once your estate surpasses £2.35 million for individuals or £2.7 million for couples.
Now, let's see how these changes affect your inheritance tax bill considering pension funds as part of your overall estate.
If a couple owned a family home worth £2 million, along with pension savings of £700,000, their total taxable estate for inheritance tax purposes, under current rules, would amount to £2 million (since pensions are still not included).
They could use their residential nil-rate band to pass on the £1 million from their home tax-free. The remaining £1 million would face a tax rate of 40%, resulting in an inheritance tax bill of £400,000.
However, from April 2027, their taxable estate would rise to £2.7 million (thanks to the inclusion of the £700,000 pension savings). Their full residence nil-rate band would be gradually phased out, leaving just their £650,000 nil-rate band to lighten their inheritance tax burden.
The loved ones would need to pay 40% on the £2.05 million that is liable for tax, resulting in a total tax bill of £820,000—more than double the previous £400,000 amount! This means your beneficiaries would receive just £1.88 million out of your £2.7 million estate!
Out of the additional £420,000 tax your beneficiaries must pay starting 2027, £280,000 would apply as IHT on the pension (40% of £700,000). The remaining £140,000 would stem from losing the residential nil-rate band (40% of £350,000, the difference between your original £2 million estate and the new £2.7 million estate threshold).
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But the tax implications don't stop here since if you die after age 75, your beneficiaries would have to pay income tax at their marginal tax rate when they make withdrawals from your pension.
For basic taxpayers, this amounts to 20%, while high earners could face up to a 45% tax rate. Consequently, once all taxes are paid, your beneficiaries could end up with merely 13% of the pension assets you left them, just £91,000 of the original £700,000!
Carl Roberts, a chartered financial planner at RTS Financial Planning, states, "One tax is bad enough, but to apply another tax once the beneficiaries have the pot is just plain greedy. It's an absolute betrayal of pensioners who have spent years saving, investing, and building what is likely to be their second biggest or, in some cases, biggest asset."
More Families to be Caught in the IHT Crossfire
The number of estates resulting in inheritance tax bills currently stands at 4.35%, according to HMRC. It's predicted to rise significantly once pension savings are taken into consideration—especially in prosperous regions like the South East and London.
The average house price is £552,000 in London and £386,000 in the South East, while the average pension pot for a person aged 65 is more than £190,000. Many families in these areas are likely to be close to the inheritance tax threshold.
The standard £325,000 inheritance tax allowance has remained unchanged since 2009, while the additional property allowance has faced no changes since 2015. They'll remain frozen till at least 2030.
Inheritance tax receipts were £8.2 billion in the fiscal year 2024-25, marking an 11% increase from the previous year. Income from inheritance tax alone reached £800 million in April 2025, representing a 14% year-over-year growth, according to HMRC stats.
In 2021/2022, around 4,500 households in London and 5,860 in the South East paid inheritance tax, versus 325 in Northern Ireland and 484 in the North East.
Protecting Yourself from the IHT Raid on Pensions
Gifting your way out
If your estate surpasses £2 million, giving gifts to loved ones is one option allowing you to keep the full residential nil-rate band of £350,000 per couple (or £175,000 per person). Learn more about inheritance tax gifting here.
You can donate up to £3,000 annually without worrying about inheritance tax. Additionally, you can make larger gifts as long as you outlive these gifts by at least seven years—if you die within seven years, your inheritance tax allowance may shrink.
Remember that these pension-related inheritance changes are still in the discussion phase, so resist acting impulsively before consulting a financial adviser or wealth planner who can help you make informed decisions for your unique situation.
- Financial advice suggests that up to 87% of a pension savings nest egg could be subject to taxes once new inheritance tax regulations take effect in 2027.
- Currently, pensions are exempt from inheritance tax, but this will change in 2027 when they will become part of an individual's overall estate for inheritance tax calculations.
- The shift in inheritance tax regulations was announced by Chancellor Rachel Reeves in her Autumn Budget last year.
- Ways to protect oneself from high taxes on inherited pensions include understanding the nil-rate band and residential nil-rate band allowances, and considering gifting some of your savings to loved ones.
- Starting a personal-finance discussion about wealth management and business strategies could help in mitigating the effects of these tax changes, giving individuals the opportunity to protect their savings, pensions, and other assets.
- It's important to note that the pension-related inheritance changes are still in the discussion phase; consulting a financial adviser or wealth planner can help you make informed decisions for your unique situation before taking action.
