The good news is there is plenty people can do to make sure loved ones still benefit from the wealth they have built up over their lifetime.
In her Budget on October 30, Reeves slapped inheritance tax (IHT) on unspent pensions when people die and froze the £325,000 nil-rate band and £175,000 main residence allowance all the way to 2030. She froze gifting allowances until 2030 too.
Reeves also targeted businesses and farmers by cutting Business Asset Disposal Relief and Agricultural Property Relief.
So how can families fight back?
The biggest and potentially most brutal Budget change of all was imposing IHT on pensions.
Today, if a pension policyholder dies before 75, they can pass on unused pension to loved ones, free of IHT.
If they die from age 75, beneficiaries must pay income tax on withdrawals at their marginal rate, either 20%, 40% or 45%.
These rules apply only to defined contribution pensions, where money is invested in the stock market.
From April 2027, unused pension will fall into your estate on death where it could face an instant 40% IHT charge.
If you die from age 75, your family may end up having to pay both IHT and income tax on the same money.
This has been dubbed a “double death tax”.
Under this scenario, if someone left £100,000 of pension chargeable to IHT, HMRC would take £40,000 straight off.
If a 40% income taxpayer drew the remaining £60,000 they would hand another £24,000 to HMRC.
They’d end up with just £36,000 of that £100,000 pension. That’s a staggering total tax charge of 64%.
An additional rate 45% taxpayer would get just £33,000 after losing 67% of the pension to HMRC. Given the sums at stake, planning is vital.
Laura Walkley, partner at wealth managers and law firm TWM Solicitors, regularly sees pension pots worth several hundred thousand pounds being inherited. “Adding that kind of money to somebody’s estate will see a lot more people paying IHT from March 2027.”
There’s another danger. “Charging IHT on pensions means more estates will be worth £2million or more. At this point, the IHT threshold falls sharply,” she continued.
For every £2 your estate is over £2million, the £175,000 residence nil-rate band shrinks by £1.
That means that at £2,350,000 your residence nil-rate band is zero.
Now for some good news. There are several things people can do to fend off Labour’s pensions tax grab.
Here are five options to get started with but there are many more. Tomorrow, we’ll deliver more details on how careful gifting can slash your IHT exposure, possibly to nothing.
Spend it. The simplest thing people can do is make sure they spend their pension before they die, rather than bequeathing it to HMRC. It’s your money, enjoy it.
Gift it. Gifting money before you die is another option, said Russell Kaminski, partner with JMW Solicitors. “Savers may now gift more wealth during their lifetime to help their children much earlier in life.”
Gifting is complex so make sure you understand the rules. More on this tomorrow, including this little-known gifting option that lets you pass on unlimited sums tax free.
Get married. When a spouse or civil partner dies, they can pass all their assets to their spouse or civil partner free of inheritance tax.
By carefully using both their £325,000 nil-rate band and £175,000 main residence allowance, they can leave assets worth up to £1million tax-free in total.
Unmarried couples cannot do that. So the surviving partner could face an IHT bill on any assets above the nil-rate band.
Buy an annuity. Annuities are a guaranteed lifetime income you can buy with your pension at retirement if you wish.
They have swung back into favour lately as interest rates rise, giving pensioners thousands of pounds of extra income each year. Now they come with IHT breaks too.
A single life annuity pays a guaranteed income for life, which stops on death. This means there is no IHT to pay.
A joint life annuity typically pays 50% income to a surviving partner. There’s no IHT to pay here either.
There are pros and cons to annuities as this article shows, but you don’t have to invest your entire pension. You could spend some on an annuity to cut IHT exposure and leave the rest invested in drawdown to grow.
Set up a trust fund. For those with significant assets, estate and IHT planning using trusts can also help mitigate a tax bill, said AJ Bell pensions and savings expert Charlene Young.
“Trusts and taxation are complex areas, so seek professional advice from a solicitor and an independent financial adviser to avoid any costly mistakes,” she advised.
Finally, keep cool. Don’t overestimate the risk and make rash decisions. Even with the changes, nine out of 10 estates won’t pay IHT.
So don’t panic and make costly errors, and avoid getting sucked into complex avoidance schemes that could easily unravel.
