LF comments on 90% effective IHT rate on pensions

An 87% effective tax rate is not a tax policy; it is a punishment for dying with the wrong assets in the wrong place.

I understand the Government’s argument that pensions should primarily fund retirement, not act as an inheritance vehicle. But layering 40% IHT onto a pension and then potentially charging the beneficiary income tax as well can create outcomes that are completely disproportionate. In AJ Bell’s example, a £400,000 pension increases what reaches the family by just £52,250. That should make policymakers uncomfortable.

For clients, this completely changes retirement planning. We can no longer lazily say “spend the ISA first and leave the pension until last”. We need to model lifetime gifting, pension withdrawals, ISA use, estate size and the residence nil-rate-band taper together.

The Government should at minimum prevent this stacking of IHT and income tax from producing effective rates approaching 90%. Tax should raise revenue. It should not create absurd outcomes.

This is a straight case of double taxation, and advisers have been warning about it since the Budget first floated bringing pensions into the estate. You're taxed once when the pension enters the estate at 40%, then taxed again when your beneficiary actually draws the money out at their marginal rate. This is what happens when you bolt inheritance tax onto a system that was already taxing pension income. The fairest fix would be to let a beneficiary's income tax bill be credited against the IHT already paid on the same pot, so you're not charged twice on the same pound.

My advice to anyone in this position is simple: don't let the pension become the most heavily taxed asset in your estate. Convert some of it to an annuity to control the income tax and remove it from your estate, use whole-of-life cover to fund whatever IHT bill remains, and spend or gift the rest while you're still around to enjoy the tax break of not having your money taxed twice.