Budget changes mean that your pension assets could be subject to an effective tax rate of up to 67%

Insight | by Stephen Kiggins

Currently, pension assets are typically excluded from an individual’s estate for IHT purposes, meaning they can be passed on free of IHT upon death. From April 2027, however, any money left in your pension will be included in your estate for IHT calculations, which means it could be subject to IHT of up to 40%.

Moreover, if the beneficiary receiving the pension assets or death benefits is an additional rate income taxpayer, then the funds would effectively be subject to an ultimate tax rate of 67%.

A worked example

Let’s examine how a £500,000 pension fund could be impacted by both Inheritance Tax (IHT) and Income Tax if inherited, with the account holder passing after age 75.

1. Initial IHT Charge
If IHT is due [because the value of the estate has exceeded the IHT nil rate band allowances] the pension funds would first be subject to the standard IHT rate of 40%, reducing the inheritance as follows:

Initial Pension Amount: £500,000
IHT at 40%: £500,000 x 40% = £200,000
Remaining Pension Funds After IHT: £500,000 - £200,000 = £300,000

2. Income Tax on Inherited Pension (if death occurs after age 75)
If the account holder passes away after age 75, the remaining inherited pension funds are subject to Income Tax at the beneficiary’s tax rate. If the beneficiary is an additional rate taxpayer, the income tax rate would be 45%:

Amount Subject to Income Tax: £300,000
Income Tax at 45%: £300,000 x 45% = £135,000
Net Amount to Beneficiary: £300,000 - £135,000 = £165,000

Total Tax Impact
From the original £500,000 pension, the beneficiary would ultimately receive only £165,000 after both IHT and Income Tax are applied, resulting in an effective total tax rate of 67%.

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This communication is for information purposes only and does not constitute financial, legal, or tax advice. Please schedule a meeting to discuss your circumstances and to receive personal financial planning advice.