Rachel Reeves’s crackdown on pension funds will drag nearly 50,000 estates into the inheritance tax (IHT) net or increase their liabilities from 2027, new analysis has revealed.
The Chancellor’s decision to include leftover pension pots in the calculation of IHT will mean grieving families could face hefty tax bills on funds previously sheltered from taxation.
In 2027/28, an estimated 10,700 estates will be hit with an IHT bill for the first time, while 38,500 estates that are already paying the tax will see their liabilities increase.
This brings the total affected estates in the first year of the measure’s implementation to 49,200, according to calculations by interactive investor (ii).
The measure’s impact will continue to grow in subsequent years, with 49,000 estates affected in 2028/29 and 54,500 estates in 2029/30.
Over three years, some 152,700 estates will face new or increased IHT bills.
Who will this affect?
Experts have warned that the move could disproportionately target middle-class families who have diligently saved for retirement but may now face unexpected tax burdens upon inheriting pension wealth.
Richard Wilson, chief executive of ii, said: “The current proposals are an affront to people who have done the right thing by diligently investing through a pension throughout their working lives to ensure financial resilience in retirement, while also taking proactive steps to create an effective estate plan that complies with existing tax rules.
“They undermine the already fragile confidence in the pensions system and could drive decisions that undermine long-term financial security.
“Including pensions in IHT calculations creates the prospect of double taxation, where the pension pot exceeds the IHT threshold, and the beneficiary is taxed again at their marginal income tax rate.
“This isn’t right, and we urge the Government to collaborate with us and the broader pensions industry to develop a simple ‘one tax’ solution.”
Currently, it is possible to pass on £325,000 without paying IHT – which is charged at 40 per cent – because of something called the nil-rate band.
This allowance can be increased by an additional £175,000 if you pass a family home to direct descendants – the residence nil-rate band. These allowances will remain frozen at their current levels until 2030.
After April 2027, when the measure will be introduced, if the total value of your estate, including any remaining pensions, exceeds the nil-rate band (and the residence nil-rate band if passing on a family home to children or grandchildren), IHT will likely become payable.
Reeves announced this change in her maiden Budget in October 2024.
What about income tax?
For those who die aged 75 or older, any pensions inherited by beneficiaries will also be subject to income tax at the beneficiary’s marginal rate.
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Read MoreThis will apply after IHT has been deducted, as beneficiaries withdraw income or lump sums from the inherited pension.
As a result, inherited pensions could be subject to “double taxation”, creating an effective tax rate of 52 per cent for pension pots passed on to basic-rate taxpayers, rising to 64 per cent and 67 per cent for higher and additional-rate taxpayers, respectively.
Experts have called on Reeves to explore alternative measures proposed by the pensions industry as part of the consultation process.
Myron Jobson, senior personal finance analyst at ii, said: “The Government appears to be tightening the screws on IHT, effectively widening the net to capture more estates.
“With thresholds such as the nil-rate band frozen for years amid rising property prices and inflation, it’s no surprise that more families – many of whom wouldn’t consider themselves wealthy – are being caught in the IHT net.
“The net will be bursting at the seams by the end of the decade if the latest proposals come to fruition.”
How much will this change bring in for the Government?
The latest figures show that the tax, despite it being widely known as Britain’s “most-hated” tax, is paid by just over 4 per cent of estates – about 27,800 a year.
According to data from the Office for Budget Responsibility (OBR), if the proposal is enacted, in the 2027/28 tax year alone, the average IHT liability is expected to be £169,000, increasing by around £34,000 when pension assets are included in the value of the estate.
Labour suggested on the day of the Budget – 30 October – that the change will raise £640m in the first year, followed by £1.34bn in 2028/29 and £1.46m in 2029/30.
But estimates by pensions consultancy LCP suggest that this figure will rise sharply through the 2030s and beyond, raising well over £3bn per year at peak.
The total yield from the change could easily exceed £40bn over the next two decades, according to the research.
Despite the backlash, Reeves has defended her Budget changes, saying she is “putting more pounds in people’s pockets”.
Others have argued the measure risks penalising responsible savers and could have unintended consequences, such as discouraging pension contributions or prompting retirees to draw down their pensions early to avoid future tax penalties.
Jobson added: “Including pensions in IHT calculations would mark a seismic shift, particularly for those who have meticulously crafted estate plans around the current rules.
“Pensions have long been considered a tax-efficient vehicle for passing on wealth, with many relying on their flexibility and exemptions as part of their broader estate strategy.
“This change would force many to rethink their plans entirely, potentially accelerating drawdowns during their lifetime to reduce tax exposure.
“It could also undermine the incentive to save into pensions, disrupting long-term financial security for future generations.”
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