New rules coming into effect from April 2027 will mean that most pensions will be included as part of an individual's estate for inheritance tax (IHT) purposes. This change could lead to inherited pension wealth being subject to both IHT and income tax in some situations.
Currently, many retirees with surplus wealth have left their pensions untouched for tax-efficient inheritance. However, the proposed changes are expected to reduce this benefit, potentially requiring individuals to reconsider their estate plans.
If a pension holder dies after age 75, beneficiaries may pay income tax at their marginal rate on inherited pension funds. If death occurs before age 75, income tax is not usually due. Where both IHT and income tax apply, the combined tax rate could exceed 60 per cent in certain cases.
One strategy to potentially mitigate this 'double tax' is to gradually withdraw money from a Self-Invested Personal Pension (SIPP) and invest it into ISAs. While money in an ISA still counts towards an estate for IHT, beneficiaries typically do not pay income tax on inherited ISA funds.
However, individuals should consider the impact of SIPP withdrawals on their own tax bracket and the annual ISA allowance, which is currently £20,000 per year. From next April, the government plans to limit cash ISA savings to £12,000 per year, with an exemption for those over 65.