HNWIs with significant pension pots could face combined tax exposure of 67% under new IHT rules

High net worth individuals (HNWI) with significant pension pots could face combined income and inheritance tax (IHT) exposure of up to 67 per cent once unused pensions are brought within the scope of IHT, according to Claritas Tax.

The tax advisory firm’s calculation assumes IHT at 40 per cent on the value of the pension and 45 per cent income tax on the balance.

From April 2027, most unused pension funds and death benefits will be included within an individual’s estate for IHT purposes.

An estimated 38,500 estates will pay more IHT, with the average liability among affected estates rising by around £34,000, according to government estimates.

“There is no silver bullet for wealthy individuals with well-funded pensions,” commented Claritas Tax associate partner, Adam Keates.

“Reducing the future IHT exposure may mean drawing money from a pension and triggering income tax during their lifetime.

“That could still be attractive compared with a potential combined tax exposure of up to 67 per cent at death.”

However, Keates warned that people should not just empty their pensions, adding that conversations with financial and tax advisers were still recommended.

“Any decision must consider the immediate income tax cost, future retirement needs and what happens to the funds once they have been withdrawn,” he added.

Claritas Tax highlighted several planning options available for those affected, including using pension withdrawals to make regular gifts from surplus income or reinvesting pension income in tax-advantaged vehicles.

It noted that retiring overseas may also impact the tax treatment of pension income, depending on the relevant double taxation agreement and the individual’s circumstances.

“The long-established approach of preserving a pension and spending other assets first may no longer be appropriate for everyone,” said Keates.

“Those with significant pension wealth should review their retirement and estate-planning strategy before April 2027.

“Tax should not be the sole driving factor of any financial decision making; the aim should not be to withdraw money solely to avoid IHT, but to determine whether paying some income tax during their lifetime could produce a better overall outcome for them and their family as part of a wider strategy for succession and financial security.”

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