Rachel Reeves inheritance tax warning – act now to protect your pension from IHT raid

In her autumn Budget, Reeves announced that she would charge IHT on unused defined contribution pension pots from March 2027. Currently, inherited pensions are exempt from IHT, although beneficiaries may have to pay income tax on withdrawals if the policyholder dies from age 75. As I’ve written before, this is a huge shift. IHT is charged at a punitive 40%, swallowing up family wealth that has already been taxed at least once.

In this case, the tax hit could be even greater. Thanks to Reeves, many families may pay both income tax and inheritance tax on exactly the same pot of money. I dubbed that a , in a punishing blow for bereaved families. Independent financial advisers are already fighting back. They’re encouraging clients to draw more money from their pots, to reduce a future IHT liability.

A new survey by Standard Life reveals that nearly 70% of advisers now recommend clients hike pension withdrawals. Previously, many left their pensions untouched to pass it on IHT-free. Now experts are urging them to take a different view.

Claire Altman, Standard Life’s managing director of individual retirement, said: “The planned extension of IHT to pensions has had a profound effect on financial planning.”

Retirees are opting to spend more of their pension savings or make tax-efficient gifts to loved ones.

However, gifting requires careful planning. Under the ‘seven-year rule’, only gifts made more than seven years before death are totally exempt from IHT.

Once assets are gifted, you relinquish control. This could leave you short if you face unexpected costs later in life, say, for health bills or social care.

Pension savers have a number of ways of mitigating that IHT hit.

Use annual IHT-free gifting allowances: Everyone can gift up to £3,000 each tax year without incurring IHT. Unused allowances can be carried over to the next year, allowing for a potential £6,000 exemption. Couples can double down. Also, we can all make IHT-free gifts of £250 a year to as many people as we like, and gifts on marriage too.

Gifting out of surplus income. Under this little-known option, you can , provided it doesn’t affect your own standard of living. Understand the rules though.

Consider charitable donations: Gifts to registered charities are exempt from IHT. If you donate at least 10% of your net estate to charity, IHT on the remainder shrinks from 40% to 36%.

Invest in business relief-qualifying assets: Investments in certain business assets can qualify for 100% IHT relief if held for at least two years and at time of death. This includes shares in qualifying unlisted companies, though such investments carry higher risks.

Establish trusts: Setting up trusts can help manage the distribution of assets and potentially reduce a future IHT bill. However, trusts are subject to complex rules and may have tax implications. Seek professional advice.

Place life insurance policies under trust. Many forget to carry out this simple step. It ensures the life policy payout doesn’t form part of your estate, thereby avoiding IHT. Beneficiaries can use the payout to cover any IHT due.

Explore annuities: Buying an annuity will convert a pension pot into a guaranteed lifetime income, reducing the remaining estate subject to IHT. With annuity rates at a 15-year high, this option has become more attractive. However, annuities typically don’t allow you to pass on anything to your heirs.

Some of these are complex, so consider taking independent financial advice or contact the government’s free Pension Wise guidance service.

There’s a much simpler way of escaping the chancellor’s IHT pensions grab – just spend it!