How changes to inheritance tax and pension 'loophole' affect you
The independent Institute for Fiscal Studies has broadly welcomed the move, while it has been branded a 'big change' by Martin Lewis.
Rachel Reeves has confirmed in her budget that pensions that are passed on when somebody dies will be taxed similarly to other inherited assets in future.
The chancellor said she will close the “loophole” around inherited pensions by bringing them under the inheritance tax (IHT) regime from April 2027.
The move was branded a "big change" by money saving expert Martin Lewis, while other experts warned it would mean many more people will be “dragged into paying inheritance tax”.
Independent think-tank the Institute for Fiscal Studies (IFS) has called the move "broadly sensible", although it has warned it "might take some political courage to see off the inevitable special pleading from those affected".
Pensions are currently exempt from IHT and are not included as part of someone’s estate when they die.
Here, Yahoo News UK explains what inheritance tax is, who pays it and how much money it raises.
What is inheritance tax?
It is a tax on the estate – such as property, money and possessions – of someone who’s died.
It is charged at 40% and doesn't affect the vast majority of the public at the moment, with the tax only applying to roughly 6% of deaths, according to Reeves.
Who pays it?
Inheritance tax is paid for the part of an estate that is above £325,000. So if an estate is worth £500,000, the tax will only be charged on the £175,000 that is above the £325,000 threshold.
Inheritance tax is not paid when the estate is below £325,000, or when the person leaves everything above that threshold to their spouse, civil partner, a charity or a community amateur sports club.
The threshold rises to £500,000 when people give their home to their children or grandchildren.
if you are married or in a civil partnership, any allowance you don’t use can be added to your partner’s allowance when they die, up to £1m.
What was announced in the budget?
Reports had suggested Labour would make changes to how inherited assets are taxed, leading to speculation that the main rate or threshold could rise.
But Reeves confirmed the existing freeze means more than 90% of estates will be exempt until at least 2030, extending by two years an existing freeze scheduled to run to 2028.
However, she announced in her budget statement that she would close 'loopholes' in the current system, including around inherited pension pots.
Pension pots are currently exempt from inheritance tax and are not included in the value of someone's estate when they die, prompting critics to complain they have been used as a tax planning vehicle to transfer wealth, rather than their original purpose to fund retirement.
It is estimated the move to tax pensions, combined with other tweaks to tax relief on inherited agricultural and business property, could raise £2bn.
Helen Morrissey, Yahoo Finance UK's pensions columnist and head of retirement analysis at Hargreaves Lansdown, said the policy has “long been considered low hanging fruit for a government in search of cash”.
She said many more people will be “dragged into paying inheritance tax” because pensions are counted as part of their estate.
Russell Miles, of wealth management firm Charles Stanley, said the policy could mean previously passive money would “now be spent, circulating a considerable amount of ‘dead’ capital in the broader economy”.
Reeves also announced changes to passing on business and agricultural land, saying: “We will reform agricultural property relief and business property relief.
"From April 2026, the first £1m of combined business and agricultural assets will continue to attract no inheritance tax at all, but for assets over £1m, inheritance tax will apply with 50% relief, at an effective rate of 20%.”
How much does it raise for the government?
According to the government's tax receipts bulletin for the 2023/24 financial year, inheritance tax raised £7.5bn. This accounted for 0.9% of the £829.1bn total tax receipts.
For context, income tax, capital gains tax and national insurance contributions raised £469.4bn: 56.6% of the total.
According to the Resolution Foundation, a left-leaning think-tank which works to improve the lives of people on low to middle incomes, the £7.5bn tax acquired by the Treasury is a tiny proportion of how much is actually bequeathed, with the estimated total flow of inheritances and gifts worth around £150bn a year.
Inheritance tax: the pros and cons
The idea of inheritance tax, as per Martin Lewis's Money Saving Expert website, "is that without it you perpetuate inherited wealth, so the children of the rich stay rich. Inheritance tax redistributes income so some of the money goes to the state to be distributed for the benefit of all".
The argument against inheritance tax is that it is, in effect, a double tax. It's an argument summed up by Jacob Rees Mogg in May 2023, when he said: "Death duties are an inefficient form of taxation that is unfair and economically damaging. Unfair because it is a double tax on already taxed assets. Economically damaging because it leads to the misallocation of capital, as investments are made to avoid a distortive tax rather than to maximise investment return.”
This has been countered by tax expert Dan Niedle, who wrote in a blog post that people often pay on assets that have already been taxed, such as petrol. In this case, not only are drivers paying for the fuel, they are also paying the fuel duty and the VAT on top of that – out of income that, for many, will also have been already taxed. He also points out it is not the person who has died paying the tax, but whoever is inheriting it. In short, he says: "There is no double tax at all, even conceptually."
Nonetheless, the "double taxation" argument is a point of view that resonates with the public. According to YouGov polling, a majority of people think it is unfair. A survey in November 2023 showed the most popular reason being because "tax has already been paid on it when earned".
Others argue that the returns on inheritance tax are relatively small. But although the current inheritance tax receipts is only £7.5bn, the IFS has pointed out that growing levels of wealth held by older generations mean total receipts could double to £15bn within the next decade.
How fair is it?
The Resolution Foundation, an independent think-tank, argues the current system is "wildly ineffective at collecting revenue" and points to a number of "loopholes and distortions" which benefit the "super wealthy".
"Inheritance taxes are more progressive, so wealthy households will face the largest cash impact overall," a spokesperson for the Resolution Foundation wrote in its overnight briefing.
John O’Connell, chief executive of the right-wing TaxPayers’ Alliance, called the decision to make pensions subject to inheritance tax "cruel and capricious".
Many argue the system needs to be reformed. Arun Advani, an IFS research fellow, said: "The design of inheritance tax at the moment is something that means the very wealthiest pay lower rates than people who are 'quite' wealthy.
"[For] people who are at, say, £2m of wealth, more inheritance tax will be paid as a percentage of that wealth on their death than someone who is at £10m."
The Resolution Foundation has also said it has an "effective tax rate of less than 5% when compared with the total flow of inheritances and large gifts".