New idea to tax inherited pensions worth £90k-plus floated - instead of imposing inheritance tax

Daily Mail​

16-07-2025

The Government is being urged to slap income tax on inherited pensions worth £90,000-plus instead of making them liable for inheritance tax.
Another option is to impose a tax charge at death on unspent pensions worth £150,000, £200,000 or £250,000, according to a finance industry group calling for a radical rethink of inheritance tax changes due in two years' time.
Just levying income tax or charges on inherited pensions direct would reduce the burden on grieving families yet still rake in around the same amount of money, The Investing and Saving Alliance has told the Government.
Tisa says its plan would also avoid unnecessary delays in sorting out estates - which can trigger interest of 8.25 per cent on unpaid inheritance tax from six months after a death - and changes in behaviour of people saving into and accessing their pensions.
Inheritance tax is levied at 40 per cent on estates above a certain size.
The Government announced in last year's Budget that money remaining in pension pots is going to become liable for the tax like other assets, such as property, savings and investments, starting in spring 2027.
The move is part of an inheritance tax raid which includes freezing the current main tax-free thresholds until 2030 and reforms to agricultural and business property reliefs.
How would taxing inherited pensions direct work?
Two alternative plans for taxing pensions at death have been offered by Tisa in a report produced in partnership with Oxford Economics.
1. Income tax
Pensions and death benefits worth £90,000-plus would be inherited as a lump sum, and beneficiaries would pay income tax at their marginal rate - meaning on any income over and above their personal allowance, currently £12,570, or higher thresholds.
Only beneficiaries who were dependants could make pension withdrawals as taxable income over time.
2. Tax charge
A standalone, flat tax charge would be imposed on inherited pension funds and death benefits above a certain threshold - and there would be no exemption for spouses.
Three potential combinations of thresholds and flat rates are suggested.
- A 25 per cent rate and £150,000 threshold)
- A 30 per cent rate and £200,000 threshold
- A 35 per cent rate and £250,000 threshold
If a saver was aged over 75 when they die, their beneficiaries would still have to pay their normal income tax rate of 20 per cent, 40 per cent or 45 per cent on pension withdrawals too
Renny Biggins, head of retirement at Tisa says: 'The Government's proposal to include unused pension funds within IHT risks creating unnecessary stress and delays for grieving families and causing long-term behavioural change among consumers that we don't yet fully understand, particularly around pension contribution levels and withdrawals.
'Instead, our research offers alternative approaches to consider, which would protect vulnerable people, support grieving families, and preserve confidence in pension saving.
'We show that you can still meet the Government's fiscal and policy goals without creating additional issues and concerns for people at the worst possible time.'
> How to avoid IHT raid on pensions: Find out your options below
Tom Selby, director of public policy at AJ Bell, says: 'While the decision to tax pensions on death is a matter for government, inheritance is arguably the most complex, time-consuming way of achieving that policy goal.
'If the Treasury refuses to budge, it will be the bereaved families of people who have saved diligently all their lives who will be left to handle this administrative nightmare.
'Anyone who has had the misfortune of dealing with IHT knows that probate can already be a tortuous process without throwing the complexity of potentially multiple pensions into the mix.'
Selby says the alternatives set out by Tisa would be 'infinitely simpler and achieve exactly the same annual cost saving to the Exchequer'.
Andrew Tully, technical director at Nucleus, says: 'Including pensions within the inheritance tax environment will deliver poor outcomes for customers, beneficiaries, personal representatives, the industry, and HMRC.
'This complex process will cause bereaved families confusion and stress at a difficult time and doesn't fit well with the support firms may want to provide people who are likely to be vulnerable following the death of a loved one.
'Most importantly it will significantly slow down the payment of death benefits and mean many beneficiaries will lose out financially after inheritance tax late payment interest penalties are levied.'
Tully believes the Tisa research demonstrates the Government could increase its tax take on wealthier people passing on pension wealth, while avoiding the numerous problems of bringing pensions into inheritance tax.
He says it should seriously consider alternatives rather than simply push ahead with the proposed 'complex and punitive' rules.
Anne Fairweather, head of government affairs and public policy at Hargreaves Lansdown, says: 'The government's proposed changes have caused confusion for people's retirement strategies and will bring extra complexity to families at an already difficult time having lost a loved one.
'The challenges of such an approach include the issues of finding lost pensions, filing the right forms, and valuing assets all within a defined period.
'Delays in the process risk families, some of whom could be dependent on the deceased's income, being left waiting for much needed money and potentially paying interest to HMRC.
'There's also the added challenge that confusion around how the inheritance tax system works may lead to people making sub-optimal decisions that they may come to regret.'
'People may think inheritance tax applies to all pensions for instance when it doesn't and make decisions based on that mistaken assumption. It could also include gifting away too much money too early and leaving people struggling later on.'
'This [Tisa] report shows that if the government is committed to tax reform of pensions on death, then there are easier ways to do it, and this should be used as a springboard for a wider discussion on the best way forward.'
How do you avoid the looming inheritance tax raid on pensions?
Many savers with larger pensions are keen to avoid the new inheritance tax levy, and there are ways to do this legitimately - though some are more sensible than others, depending on your wealth and personal circumstances.
First off, consider consider if you really are likely to have a big enough estate to pay inheritance tax, especially after you have spent down your pensions and other assets during retirement.
Check the rules in the box further below, before you start worrying about your beneficiaries paying inheritance tax after you are gone. If you have cause for concern, consider the following options.
1. If you can afford it, you can spend or gift as much of your pensions as possible, while avoiding a big income tax bill.
Recent research showed many savers with larger pensions intend to spend them by splashing out on more holidays.
Bear in mind it is better to avoid crystallising losses by making bigger pension withdrawals in market downturns.
2. Consider gifting out of surplus income, which remains inheritance tax-free providing you can afford it.
We explain how to do this and prove to the taxman you are doing it from actual surplus income.
A This is Money reader explains how he is doing this to pass his wealth to his two daughters.
3. Look into buying life insurance and putting it in trust.
This can mean your loved ones get a payout straight after your death and free of inheritance tax - but you have to set it up correctly.
Here's how to put life insurance into trust, but be aware that premiums can be high especially as you get older, and if you cancel a policy you immediately lose all the benefits of taking it out in the first place.
4. Leave more or all of your estate to your spouse, who can still benefit from estates free of inheritance tax, instead of your children to delay and minimise the eventual bill.
Wealth manager Evelyn Partners has suggested there could be a marriage boom or rise in civil partnerships among older couples as a result of the inheritance tax changes - read its six options to cut inheritance tax on pensions.
5. Buying an annuity is another option which Evelyn Partners explores.
Meanwhile, beware - although some people have raised the idea of siphoning pension funds into stocks and shares Isas, these are also liable for inheritance tax, and there are other pitfalls.
A financial planner from Quilter Cheviot explains how switching pensions into Isas can backfire.
How much is inheritance tax and who pays?
Inheritance tax is levied at 40 per cent on estates above a certain size.
You need to be worth £325,000 if you are single, or £650,000 jointly if you are married or in a civil partnership, for your loved ones to have to stump up inheritance tax.
A further allowance, the residence nil rate band, increases the threshold by £175,000 each - so £350,000 for a married couple - for those who leave their home to direct descendants. This creates a potential maximum joint inheritance tax-free total of £1million.
This own home allowance starts being removed once an estate reaches £2million, at a rate of £1 for every £2 above the threshold. It vanishes completely by £2.3million.
Chancellor Rachel Reeves said in the Budget these thresholds will be frozen until 2030.