People have until April 6, 2027, to take action
Samuel Mather-Holgate(Image: Newspage)
An expert has warned of a double tax trap coming next year that leaves “people shocked when they see the maths written down”.
Millions of families could face a major pension tax shock from April 2027, with experts warning that inherited pension wealth may end up being hit by both inheritance tax and income tax at the same time. For years, pensions have been viewed as one of the most tax-efficient ways to pass wealth down to the next generation because unused pension pots generally sat outside a person’s estate for inheritance tax purposes.
But that is set to change from April 6, 2027, when most unused pension funds and pension death benefits will be brought into scope for inheritance tax by HMRC. Financial advisers say many families still do not fully appreciate how severe the combined tax impact could become.
Samuel Mather-Holgate, managing director and Independent Financial Adviser at Swindon-based Mather and Murray Financial, said some beneficiaries could ultimately lose more than two-thirds of inherited pension wealth once both taxes were applied.
He added: “A lot of people still assume pensions are safely outside inheritance tax, but from April 2027 that assumption could become dangerously outdated. The real problem is that families may not just face inheritance tax. In some cases, beneficiaries could then pay income tax on top when they draw money from the inherited pension.”
That is where the so-called “67% tax trap” comes from. If a pension fund is first hit by 40% inheritance tax, only 60% of the original pot remains. If the beneficiary then pays income tax at 45% on withdrawals from that remaining amount, the combined effect means 67% of the original pension wealth disappears to tax overall.
In some cases, the tax hit could become even more severe. Beneficiaries paying Scotland’s top 48% income tax rate could lose almost 69% overall, while those caught in the personal allowance taper zone could effectively face a combined tax hit of up to 76% on part of the inherited pension.
Mr Mather-Holgate said: “People are understandably shocked when they see the maths written down properly. This is not some theoretical loophole or gimmick. It is simply two separate tax systems potentially colliding with one another.”
He warned that the changes could fundamentally alter traditional retirement and inheritance planning strategies. For many years, advisers often encouraged retirees to spend other assets first while leaving pensions untouched for as long as possible because of their favourable inheritance treatment. But that logic may now need revisiting.
Mr Mather-Holgate said: “This could completely change the old ‘spend your ISA first and preserve your pension’ strategy. That does not mean everybody should suddenly empty their pension, but it does mean families need to review whether their current plans still make sense under the new rules.”
He said many people also underestimate how important beneficiary planning could become: “A pension left to one beneficiary could create a very different tax outcome compared to leaving it to somebody else in a lower tax bracket. Beneficiary nominations are no longer just admin paperwork. They are becoming a key part of tax planning.”
Despite the looming changes, Mr Mather-Holgate stressed there were still opportunities to reduce the eventual damage through proper financial planning, gifting strategies and reviewing how pensions fit into wider estate plans. But he warned that many families were leaving things late.
He added: “The worst time to discover a double-tax problem is after somebody has died. From now until April 2027, people have a window to review their arrangements properly before these rules potentially start biting.”
