Under new HMRC inheritance tax rules introduced by the Labour Party government, UK households will face a "double tax" hit on unspent pension pots and a strict six-month deadline to pay. This change combines with Income Tax on withdrawals to create a significant extra burden for some estates, adding layers of complexity to an already challenging system for grieving families.
How the New Rules Work
Beneficiaries must decide whether to instruct pension providers to pay a proportional share of the overall inheritance tax (IHT) bill from the pension itself (if £1,000 or more) or cover the full liability from other assets. Providers must then pay HMRC within 35 days of notification. However, this choice can leave some family members worse off, depending on their tax positions.
Henrietta Grimston, Chartered Financial Planner at Saltus, said: "When deciding how best to divide up responsibility for the IHT bill, personal representatives must ensure they do not inadvertently put one or more beneficiaries at a disadvantage. In some cases, beneficiaries may be better off instructing the pension provider to pay a portion of the IHT due on the unspent pension."
Income Tax on Withdrawals
For those who die after age 75, lump sums or withdrawals taken by beneficiaries will be taxed at their marginal rate of Income Tax – up to 45% for additional rate taxpayers. This means the pension pot could be subject to both IHT and Income Tax, creating the "double tax" scenario.
Ms Grimston added: "Administratively, these new rules are hard to meet. Managing multiple pension providers at once, getting the valuation of the unspent pension and working out the proportional share on each of those pensions is a time-consuming process. The danger here is that, keen to avoid late payment fees, many beneficiaries will rush the early stages of the process and ask the pension provider to settle a share of the IHT owed. While this may seem to be a sensible approach at first, it can ultimately leave some beneficiaries worse off in the long run."
Guidance and Next Steps
Ms Grimston said: "While some question marks remain around how this new regime works, the Government’s latest guidance has provided some transparency. While there is no one-size-fits-all solution, anyone thinking of taking immediate action to reduce their liability must know what their tax rate is to withdraw from the pension, what their children’s or beneficiaries’ tax rates are, and what other assets they have. Only then will they be able to take an informed, holistic view of their finances and understand the most tax-efficient route forward."
The new rules place a heavy administrative burden on personal representatives and beneficiaries, who must navigate complex decisions within tight deadlines to avoid penalties.
