Pensioners take £20k hit to swerve inheritance tax

Pension savers are choosing to pay an extra £20,000 in income tax to avoid Rachel Reeves’s death duty raid, advisers have said.

Taxpayers with large pension pots are rushing to withdraw cash to avoid a “triple tax hit” on death, after the Chancellor dragged private pensions into the inheritance tax net from 2027.

Nick Nesbitt, of accounting firm Forvis Mazars, said he had seen a “significant increase” in clients drawing down pension assets, and incurring higher income tax bills as a result.

He added: “Lots of clients who were looking to save their pension before the Budget are now drawing more income out and accepting higher tax bills.

“The strategy previously was to limit withdrawals to £50,000 a year so you are only paying a marginal rate of 20pc. But people are now raising the yearly income to £100,000 and taking the 40pc tax hit.”

Inheritance tax is levied at 40pc on all assets over £325,000, with an additional £175,000 allowance if you are passing on a main residence to a direct descendant. Labour’s plan means unspent pension wealth will be included in the calculation from April 2027.

However, beneficiaries of those who die over the age of 75 will also have to pay income tax at their marginal rate when they withdraw the inherited pension savings.

In addition, estates worth over £2m lose the main residence relief at a rate of £1 for every £2 over the threshold, meaning the whole allowance is lost once the estate is worth over £2.35m.

This combination of taxes means some grieving families will face tax bills on pension assets of up to 90pc, according to accountancy firm RSM.

Clients are therefore choosing to withdraw more money from their pot today and incur a higher income tax bill to avoid this “triple hit” for their heirs when they die, according to Mr Nesbitt.

Under current rules, savers can take 25pc of their pension pot tax-free from the age of 55 (rising to 57 from 2028), up to a maximum of £268,275. All other withdrawals are treated as income and taxed accordingly.

Someone moving from withdrawing £50,000 from their pension to £100,000 in one year can expect to see their tax bill increase by around £20,000.

Clients are usually not advised to withdraw more than £100,000 in a single year because of the “60pc tax trap”, Mr Nesbitt said. For every £100 of income earned between £100,000 and £125,140, £40 is deducted in income tax, while another £20 is lost from the tapering of the personal allowance.

He added: “We were previously working on people being able to pass on pension assets with 15pc to 20pc total tax to them and their beneficiaries.

“Now this needle can very easily swing up to 60pc or 70pc. People are wrestling with how they get back to a reasonable level they’re comfortable with.”

In a letter to the Chancellor in January, the bosses of Hargreaves Lansdown, AJ Bell, Interactive Investor and Quilter – which collectively manage around £430bn for British savers – called on the Government to reverse the inheritance tax raid on pensions announced at the Budget in October.

They claimed that Ms Reeves’s plans would hurt lower-income savers by increasing complexity and “compound an already difficult situation” for bereaved families.

Jason Hollands, of wealth manager Evelyn Partners, said some of his clients had intended not to touch their pensions for as long as possible, but the changes from 2027 have upended that plan.

He added: “You’ve got to take into account the post-tax impact when you withdraw pension savings, that’s important to consider. Some people will be taking tax-free cash, some people are increasing their withdrawal rate.

“Age and health need to be considered when deciding how much to take out. If you’re healthy, basically, you have longer to extract money.”

The Treasury was approached for comment.