EXCLUSIVE Could you fall into the pension inheritance tax trap? We reveal how four families could face huge bills

Daily Mail​

19-05-2025

Inheritance tax has historically been something only the very wealthiest pay, but we can reveal the huge tax bills families could be saddled with by 2030 thanks to a looming raid on pensions.
Frozen thresholds combined with rising asset prices, including the value of homes, investments and savings, are already dragging more into death duties.
But a massive change to how estates are calculated is on the cards, with pension pots due to be included from 2027 - and this will bring far more families into the inheritance tax net and drive up their bills.
Some families will end up paying tens or even hundreds of thousands of pounds more in inheritance tax.
To illustrate the impact, exclusive figures for This is Money from wealth management firm Evelyn Partners show how four example families who would currently have small, or in one case no inheritance tax liability, could instead face hefty tax bills by 2030.
We look at what an IHT bill will cost now and what it is likely to increase to within five years, once changes have filtered through.
Ian Dyall, head of estate planning at Evelyn Partners says: 'These imaginary but realistic case studies illustrate the inheritance tax liability impact of both asset value inflation against nil-rate bands that are frozen until at least 2030, and crucially the pensions rule change that is due to come into force at the start of the 2027/28 tax year.'
Currently, unspent pension pots are considered outside of people's estates for inheritance tax purposes.
But from April 2027, the Government wants to include them under plans announced by Rachel Reeves in her Autumn Budget.
This could potentially lead to double taxation and rates as high as 67 per cent on unspent pots.
This is due to current income tax rules on inherited pensions that differ depending on the age at which someone dies.
If you die before age 75, the beneficiaries of your pension can take the pot free of income tax. But if you die after the age, beneficiaries pay income tax on withdrawals from inherited pensions. Adding inheritance tax at 40 per cent to the latter case too, would lead to double taxation and sky-high marginal rates on withdrawals.
It's likely that one in 10 estates will soon be in the IHT net - with the Treasury forecast to rake in £14.3billion extra between now and the 2029-30 tax year.
Below, we lay out four hypothetical scenarios to illustrate how the inclusion of pensions for IHT purposes will create financial headaches for many families.
Inheritance tax: How it works
Inheritance tax is levied at 40 per cent on estates above a certain size.
Your estate is the term given to all the things that you own at death. Valuing this involves adding up everything, from your stake in your home, to your savings and investments, your car and your personal belongings.
As an individual, your estate needs to be worth more than £325,000 for your loved ones to have to stump up inheritance tax.
This can be doubled to £650,000, jointly, for married couples or civil partners, who have not already used up any of their individual allowances.
A further crucial allowance, the residence nil rate band, increases the threshold by £175,000 each for those who leave their home to direct descendants.
This gives a total potential extra boost of £350,000 and creates a potential maximum joint inheritance tax-free total of £1million.
But the own home allowance starts being removed once an estate reaches £2million, at a rate of £1 for every £2 above the threshold.
> Essential guide: How inheritance tax works
Four families and how they could be hit for IHT
Our table highlights the four example families, with their inheritance tax position now and the situation they could find themselves in from 2030.
The blue line in the table represents their assets and the total value of their estate now, while the green line shows this in 2030 after assets have risen in value and pension pots have been included.
The column stating Taxable Estate shows how much of it would incur inheritance tax now and in 2030 once pension pots are included (the Smiths negative figure shows they currently are below the inheritance tax level).
The IHT Due column shows the tax bill now in blue and the future potential tax bill in green.
We explain the scenarios in more detail below.
Scenario one: The Smiths, late 30s
A couple in their late 30s with a young family might not be considering inheritance tax as an issue at this stage of their lives. But it's important to remember that, however morbid the thoughts involved, families can be left with a huge tax bill at any age if disaster strikes.
Often people don't think about IHT until it's too late and little can be done to mitigate the potentially hefty charge, so those who could be pushed over the limit should seek advice, whatever their age.
Our figures from Evelyn Partners show how the children of a couple in their late 30s, who would not have to pay IHT if their parents both died today, could face a hefty bill in five years.
In our scenario, the Smiths' own a £750,000 house, with £400,000 left on their mortgage and £500,000 in defined contribution pensions between them, with both contributing £500 a month.
They have also saved £50,000 into their Isa and £20,000 in cash.
This means their total assets add up to £1,320,000, but their estate is valued at £420,000 after deducting mortgage debt (£400,000) and their combined pension pots of £500,000.
Under the current IHT rules, this couple are well within their combined £1million nil rate band and residence nil rate band allowances, with £580,000 to spare, which means their estate wouldn't face any inheritance tax.
Looking to the future, Evelyn Partners assumed the assets appreciate by 5 per cent a year, except cash savings, which increase by 2.5 per cent annually. Their mortgage will reduce as repayments continue and their pensions grow due to investment returns and contributions.
This means the family's home would be worth £962,520 in 2030, while their repayment mortgage would have been paid down to £300,000, and their pension pots would be worth a combined £709,685.
Their Isa and savings pots will have increased to £64,168 and £22,660, respectively, assuming no further contributions between now and 2030.
The Government's plan to pull pensions into inheritance tax, along with growth in the family's assets, radically change their IHT position.
By 2030, their estate has more than tripled to £1,459,033, once their £300,000 mortgage debt is deducted.
This leaves £459,033 of their estate above the inheritance tax-free allowances, meaning that they could owe £183,613 in IHT.
Scenario two: The Murrays, mid-50s
Our second couple are the Murrays, who are in their 50s with grown-up children. They're wealthier than the Smiths, with a more valuable home and bigger combined pension pots.
Their £1million home (£900,000 of which is mortgage-free) and £1million in pension pots, plus £100,000 in Isas and £50,000 in cash, bring their total assets to £2,150,000.
Today, inheritance tax isn't a major concern as they are just over the limit. Deducting their mortgage debt and pension pots brings their total estate to £1,050,000, with their taxable estate at £50,000 after the IHT allowances.
This means this £50,000 chunk of their estate would currently be liable to a 40 per cent IHT bill of £20,000, because their pension pots are not included.
However, in five years, this family could face an inheritance tax charge of more than £800,000, primarily because of the pensions raid, along with fiscal drag from frozen thresholds.
Assuming this family's assets had appreciated by 5 per cent annually, with cash savings up 2.5 per cent each year, and their mortgage now fully paid off, their total assets would be £2,846,914.
As the couple's combined estate exceeds £2.7million, on the second death the residential nil rate band benefit would be fully tapered away. With this gone their inheritance tax-free allowance is only £650,000 rather than £1million.
Their taxable estate in 2030 could now be £2,196,915, rather than the current £50,000, leaving their beneficiaries with a bill of £878,766.
Scenario three: The Taylors, late 60s
The Taylors are a retired couple in their late 60s with total assets of £2,650,000.
They live in a large detached home in the South East that is worth £1.25million and they cleared the mortgage on it some time ago.
Many of their generation had defined benefit pensions, which are lost on the second spouse's death, but the Taylors built up defined contribution pensions instead and have combined pots worth £1.25million. Alongside, this they have £100,000 in Isas and £50,000 saved in cash.
Their £1,250,000 combined pension pots are currently exempt, which means that their estate is worth £1,400,000, with a taxable estate above the IHT threshold of £400,000.
This leaves their adult children - they have no grandchildren - with a £160,000 inheritance tax bill if they were both to die today.
However, by 2030, their estate could be worth £3,004,200, assuming their pensions and savings maintain their monetary value as they draw on them.
If both of the Taylors died in 2030 they would still be under the age of 75, which means that their pension funds will not be liable to income tax when their beneficiaries withdraw funds.
But their pension pots will now be included for inheritance tax purposes.
Like our couple in their 50s, they only qualify for the £650,000 nil rate band and not the residence nil rate band because their estate is now valued at over £2.7million.
This means that their taxable estate is £2,354,200 with an IHT bill of £931,680.
Scenario four: The Joneses, over 75
Our last retired couple are in a similar financial position to our previous family, the Taylors, but by 2030 will be over the age of 75.
This means their pension beneficiaries - their adult children and grandchildren - will have to pay income tax at their marginal rate, if they withdraw funds from the inherited pots.
While their £1,500,000 house will have increased in value to nearly £2,000,000, we assume their pensions, investments and savings have now been reduced.
However, growth in their home's value along with adding the remaining pension pots, means their total estate for IHT purposes will have increased from £1,650,000 to £3,035,040.
Currently, their taxable estate above the combined £1million inheritance tax threshold is £650,000 with a tax bill of £260,000.
In 2030, the value of their estate, now including the remaining pension, will have exceeded the amount that allows the family to claim the residence nil rate band.
This means that their taxable estate will soar to £2,385,040 with the beneficiaries left liable to pay £954,016 in IHT.
But there is a double whammy, as they die after the age of 75, their beneficiaries will face inheritance tax on their pension pot - and pay income tax on withdrawals.
Ian Dyall says: 'This means that on the £600,000 of inherited defined contribution pension cash remaining after £400,000 IHT has been removed, the beneficiaries – if higher rate taxpayers – could have to pay a further 40 per cent or £240,000 in income tax, leaving just £360,000 from a £1million pension pot.
'However, one thing in this family's favour is that the elderly parents have spent (and/or possibly gifted) some of their savings, Isa and pensions, thus limiting the IHT liability at death, leaving it only marginally greater than the third family.
How can you lower your pension raid IHT bill?
These case studies show how quickly families will be hit with a huge IHT liability once pensions are included within people's estates.
The seven-year rule on gifts, after which they pass out of your estate for IHT purposes, has not yet been changed, so gifting can be one way to lower your bill.
Dyall says: 'Our case studies also illustrate the potential power of spending or gifting savings to limit an IHT liability, particularly in a situation where unspent pension pots are subject to IHT.
You can gift £3,000 a year, plus unlimited small gifts of £250, free from IHT, and spouses and civil partners can give each other any sum tax-free.
Gifts can be made beyond this but the person making them must survive seven years for them to fully come out of the inheritance tax net, tax would be incurred on a sliding scale in the meantime.
There is also an inheritance tax exemption for regular gifts made out of surplus income, which some may consider. Record keeping and proper research is vital here.
Dyall says that spending more of their pension could prove to be a wise move for many, who could otherwise face big bills.
'That is not to say of course that elderly savers with unspent pension assets should start to withdraw suddenly and splurge,' says Dyall.
'Everyone will sensibly want to make sure they retain access to enough funds to have a comfortable retirement and to pay for social or residential care if it becomes necessary.
'But pensions after 2027 are likely to return to their primary purpose of funding retirement and as such are savings that can be spent or given away by the saver - with one eye on the income tax consequences.
'I sometimes say to certain clients, "Think of it like everything you use this money for comes at a 40 per cent discount"'.
'But they still need a good retirement plan that shows them how much they can afford to spend and / or gift in various circumstances, and for that it is hard to beat professional financial planning advice, which will provide cash flow analyses for different scenarios.'