Grieving families now face an “eye-watering” charge of up to 84% on their inheritances thanks to chancellor Rachel Reeves.
Families could hand over 84% of inherited pension under Labour’s double death tax (Image: Getty)
Christmas is a time for giving and this year families have an extra incentive to be generous as they take evasive action against Labour’s Budget tax raid.
Kirsty Limacher, legal consultant at The Association of Lifetime Lawyers, said people aren’t hanging around. “Three quarters of our members report an increase in people asking advice on gifting money to save inheritance tax since the Budget.”
They’re right to do so with HMRC set to pocket a record £8billion this year.
That will surge again from April 2027, when Reeves follows through on her Budget pledge to slap inheritance tax (IHT) on unused pension pots too.
It’s going to have an even more brutal impact than most people realise.
IHT is charged at a punitive flat rate of 40% on assets above the £325,000 nil-rate band, and the £175,000 main residence band for inherited family homes.
Thanks to Reeves, thousands of families now face a double death tax on inherited pensions.
First, IHT will be deducted from liable pensions when the policyholder dies at the standard rate of 40%.
So if £100,000 of pension is subject to IHT, beneficiaries will get just £60,000.
Second, families may have to pay income tax on the money too. Under existing rules, if the policyholder dies aged 75 or over, family members pay income tax on withdrawals at their marginal.
So that’s another 20%, 40% or 45%, depending on their tax band.
So a 20% taxpayer will hand over another £12,000 to HMRC. They’ll get just £48,000 for themselves, less than half the original £100k.
Their total tax rate is 52%. That’s a brutal rate for a basic rate taxpayer and it gets worse.
A 40% taxpayer will end up with just £36,000 after IHT and income tax, a total tax charge of 64%. An additional rate 45% taxpayer will get just £27,000. Their tax charge is a brutal 67%.
Incredibly, it gets even more brutal.
Some better-off families with incur a forgotten IHT penalty on top, said Ed Monk at Fidelity International. This will hike the total tax charge to an “eye-watering” level, he said.
Under a little-known IHT rule, if the total value of somebody’s estate tops £2million, HMRC cuts the £175,000 main residence by £1 for every £2 above that sum.
Once the estate exceeds £2.35million the £175,000 band disappears altogether, Monk said. “Reeves move to include pensions in estates means many more will be impacted.”
Some families could be left with a mere £16,000 of the original £100,000. That tax rate is an unfathomable 84%. We’re back to tax rates Labour imposed in the 60s and 70s.
While this will only hit small numbers today their numbers will steadily grow over time. Especially since inheritance tax bands have been frozen since 2009 and gifting allowances since 1981.
It’s all part of a relentless government raid on family wealth.
Reeves’ plan will surely backfire as families fight back. Many would rather spend every penny of their pension rather than see it taxed to oblivion. Others will gift it. Christmas is the ideal time.
Any gift is completely free of inheritance if you live for seven years after making it.
Even if you don’t, that 40% tax charge falls on a sliding scale under taper relief. By year seven it’s down to just 8%.
Some gifts are instantly IHT-free. Today, everyone can gift £3,000 to anybody they like with instant IHT exemption, called the annual exempt amount. Couples could gift £6,000.
If they didn’t use last year’s gift allowance, they could up that to £12,000.
They can also give unlimited gifts of up to £250 to as many people as they like every year, provided they haven’t benefited from the £3,000 exemption.
Laura Suter, head of personal finance at AJ Bell, said you can also make IHT-free gifts when loved ones marry. “These are up to £5,000 for a child, £2,500 for a grandchild and £1,000 for anyone else.”
Gifts to help pay the living cost of an ex-spouse, an elderly dependent or child under 18 or in full-time education may also be exempt.
In a little-known exemption, you can make unlimited gifts out of surplus income, entirely free of IHT.
Document everything you do carefully, to avoid questions later.
With a bit of effort (and maybe some financial advice) you can play Santa with your family this Christmas, while acting like Scrooge to HMRC.
