Chancellor of the Exchequer Rachel Reeves (Image: WPA Pool, Getty Images)
An expert has cautioned about a double tax trap set to arrive next year that leaves “people shocked when they see the maths written down”.
Millions of families could be facing a significant pension tax bombshell from April 2027, with specialists warning that inherited pension wealth may be hit by both inheritance tax and income tax simultaneously. For many years, pensions have been regarded as one of the most tax-efficient methods of passing wealth down through the generations, as unused pension pots generally fell outside a person’s estate for inheritance tax purposes.
However, that is all set to change from April 6, 2027, when most unused pension funds and pension death benefits will be brought within the scope of inheritance tax by HMRC. Chancellor Rachel Reeves announced the changes in her autumn statement in 2024 and they begin at the start of the next tax year in 2027.
Financial advisers warn that many families still fail to fully grasp just how severe the combined tax burden could become. Samuel Mather-Holgate, managing director and Independent Financial Adviser at Swindon-based Mather and Murray Financial, warned that 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still assume pensions are safely outside inheritance tax, but from April 2027 that assumption could become dangerously outdated.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.”
It could lead to unexpected bills (Image: clubfoto via Getty Images)
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This is the origin of the so-called “67% tax trap”. When a pension fund is initially subject to 40% inheritance tax, only 60% of the original pot remains. Should the beneficiary then pay income tax at 45% on withdrawals from that remaining sum, the combined effect means 67% of the original pension wealth is swallowed up by tax altogether.
In certain circumstances, the tax burden could become even more punishing. Beneficiaries subject to Scotland’s top 48% income tax rate could lose nearly 69% overall, while those caught within the personal allowance taper zone could effectively face a combined tax hit of up to 76% on a portion 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.”
Samuel Mather-Holgate (Image: Newspage)
He cautioned that the changes could fundamentally reshape traditional retirement and inheritance planning strategies. For many years, advisers routinely encouraged retirees to draw down other assets first while leaving pensions untouched for as long as possible, owing to their favourable inheritance treatment. Yet that rationale may now require fresh consideration.
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 also noted that many individuals underestimate the significance of beneficiary planning: “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 impending changes, Mr Mather-Holgate emphasised that there remained opportunities to mitigate the eventual impact through careful financial planning, gifting strategies and reassessing how pensions sit within broader estate plans. However, he cautioned that many families were leaving it too late to act.
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.”