Experts warn that taxing pensions before retirement would be ‘unbelievably unfair’ and could discourage long-term saving
Labour has confirmed that inheritance tax (IHT) will apply to workers’ retirement savings even if they die before reaching pension age – a move some experts are calling “abhorrent”.
Rachel Reeves announced in last year’s Budget that from April 2027, pension pots will be subject to Britain’s “most hated” tax.
Currently, unspent pensions are typically passed tax-free to beneficiaries at trustees’ discretion. Under the new rules, these funds could be taxed up to 40 per cent as part of the estate if it exceeds the IHT threshold.
Until recently, it was unclear whether IHT would apply if someone died before age 55 – the earliest age to access pensions.
Now, HMRC has confirmed the tax will apply even if the saver never accessed their retirement funds.
Ian Cook, chartered financial planner at Quilter Cheviot, told The i Paper: “Charging IHT on an asset you have to accrue and are automatically enrolled into, before retirement age, is abhorrent.
“It’s particularly brutal when someone will have built up with 20 per cent tax relief on pension contributions if they’re a basic rate taxpayer but then pay 40 per cent when they die.
“It’s a disincentive for people to save for the long term. The message to the wider public is: don’t save into your pension.”
Currently, retirees can withdraw amounts from age 55, though the minimum pension age will rise to 57 in April 2028.
IHT is charged on assets above the £325,000 nil-rate band, with an additional £175,000 allowance if the main residence is passed to direct descendants.
Pensions can be inherited tax-free if the deceased is under 75, up to £1.07m. If over 75, beneficiaries pay income tax on inherited pensions.
Reeves’s changes will impose up to 40 per cent IHT on unspent private pension pots, expected to raise about £1.5bn annually for the Treasury by 2029-30.
The Investing and Saving Alliance (Tisa) has urged the Chancellor to exempt savers with pensions under £90,000 from the tax.
Tom Selby, director of public policy at AJ Bell, called it “a particularly brutal hit to their beneficiaries at a time that will be extremely emotionally and financially distressing”.
But he noted few people die before 55, and only “a very, very small proportion” would pay IHT.
He added: “Confirmation that death-in-service payments will not count towards people’s estate for IHT purposes makes this even less likely. So, the Government could look at this, but the impact of any carve-out along these lines would be vanishingly small.”
Death-in-service payments are lump sum payments made to a deceased employee’s beneficiaries, usually family members, by the employer when the employee dies while still employed.
They will be excluded from the value of an individual’s estate for IHT purposes.
Sir Steve Webb, former pensions minister and partner at LCP, accepts that Reeves’s change has to happen, but said creating an IHT exemption would create a new unfairness.
He explained: “In this case, there could be a big difference in the impact on the family finances simply because of a few days either way.
“There is already an arbitrary difference for deaths before and after 75, where income tax is due if someone passes money on for a death over 75, but inheritances are income tax-free under 75.
“Age cut-offs like this create a different unfairness and it would be undesirable to create a new cut-off.”
Caitlin Southall, director of SSAS transformation and proposition at WBR Group, called the move “unbelievably unfair”.
She said: “If people cannot use these funds under current rules, why should they be subject to IHT? The Government is creating significant barriers for people to save responsibly for their retirement.
“By all means encourage people to use pensions for later-life saving, and not as a wealth transfer tool, but this is not the way to do it.”
The Government has been contacted for comment.