Families across Yorkshire risk sleepwalking into 60 per cent pensions tax trap - Monika Bone
Families across Yorkshire are at risk of losing up to 60 per cent of their inherited pension savings when the Government’s changes to inheritance tax come into effect next year. In my work helping families in our region with their wills and estate planning, I am seeing growing concern about the potential consequences of these changes.
Currently, most individuals can pass on up to £325,000 free of inheritance tax, with an additional £175,000 allowance when leaving a main home to direct descendants such as children or grandchildren. When combined between spouses, this means a couple may be able to pass on up to £1m without incurring inheritance tax.
However, from April 2027, any unused pension funds will be included in the value of a person’s estate when they die, potentially pushing more families above the tax-free threshold at which inheritance tax becomes payable at up to 40 per cent and leaving their pension pots exposed.
Depending on the pension holder’s age when they die, their beneficiaries may then also be subject to income tax when they withdraw the inherited funds. Once inheritance tax and then income tax are applied, this could result in an effective tax rate of more than 60 per cent.
For example, consider a person who dies after the age of 75 with an estate that already exceeds the tax-free threshold. Let’s say they also have pension savings worth £400,000. This pot could be fully exposed to inheritance tax at 40 per cent, reducing it to £240,000.
If the remaining sum is then withdrawn by a higher-rate taxpayer, a further 40 per cent could be lost to income tax.
That would result in £266,000 of the pension being lost to tax in total – more than 60 per cent – leaving just £144,000. This shows how quickly the combined tax burden can reduce the value of inherited pension savings.
Rising property values – along with a threshold that has been frozen at £325,000 since 2009 – are already drawing more families into inheritance tax, even though they may not consider themselves particularly wealthy.
The Government says the upcoming changes are intended to discourage the use of pensions to pass on wealth, rather than fund retirement. They estimate that around 10,500 estates will face an inheritance tax bill for the first time as a result, while another 38,500 could see their liabilities increase.
As well as the considerable financial implications, the reforms are also likely to increase stress for families administering estates. The latest details released by HMRC confirm some of the extra burden families are likely to face, with personal representatives responsible for identifying pension assets, reporting their value and ensuring any inheritance tax due is paid.
These changes may come as a surprise to many Yorkshire families, as what was once seen as a tax-efficient safety net now presents a potential tax trap.
While April 2027 may seem a long way off, I would strongly advise people to start reviewing their estate planning now, particularly where pension savings make up a significant part of their wealth.
Early planning can help families understand the impact of the changes and avoid tax shocks down the line.
Monika Bone is a York-based wills, estates and tax planning specialist at law firm Wilkin Chapman Rollits.