An update following enactment of the Finance Bill.
The Finance Bill included provisions for bringing pension entitlements into charge to IHT on 6 April 2027.
The problem was that if the pension fund is subject to 40% IHT and then income tax at rates up to 45% on drawdown, this would be serious double taxation.
Fortunately, the Finance Bill included a deduction for the IHT against the amount of the pension income charged to income tax, which had the effect of reducing the effective tax rate considerably.
However, the Finance Bill was subsequently amended and the Finance Act 2026 (enacted on 18 March) has some very different provisions.
Without going through all the changes line by line, I would explain that the final version means that for deaths under age 75, the IHT deduction works fine, just as before.
This is because if the pension fund is £1,000 and the IHT is £400, there is only £600 left – and when that is paid out, there is a deduction from the £600 pension income of the £400 IHT paid. So only the balance of £200 is charged to income tax – resulting in an extra £40 for a basic rate taxpayer giving a total effective rate of 44% – and an effective rate of 48% and 49% for higher rate taxpayers.
However, on a death after 75, there is now a restriction which denies the credit for the IHT paid by the pension fund. You can get credit for the IHT if you pay it personally – but that is not much help. It leaves the pension fund with £1,000 to pay out and not just £600. That results in income tax of £120 (i.e. total tax of £520 which is 52%), or £240 (total tax £640 which is 64%) or £270 (total tax £670 which is 67%).
Anybody over the age of 75 who has not yet drawn their pension is likely to regard this as a tad unsatisfactory. Having followed the rules scrupulously for 50 years in saving for his pension (which is supposed to be a Good Thing), he now finds he is going to lose two thirds of it because the Treasury has changed the goalposts.
An update following enactment of the Finance Bill.
The Finance Bill included provisions for bringing pension entitlements into charge to IHT on 6 April 2027.
The problem was that if the pension fund is subject to 40% IHT and then income tax at rates up to 45% on drawdown, this would be serious double taxation.
Fortunately, the Finance Bill included a deduction for the IHT against the amount of the pension income charged to income tax, which had the effect of reducing the effective tax rate considerably.
However, the Finance Bill was subsequently amended and the Finance Act 2026 (enacted on 18 March) has some very different provisions.
Without going through all the changes line by line, I would explain that the final version means that for deaths under age 75, the IHT deduction works fine, just as before.
This is because if the pension fund is £1,000 and the IHT is £400, there is only £600 left – and when that is paid out, there is a deduction from the £600 pension income of the £400 IHT paid. So only the balance of £200 is charged to income tax – resulting in an extra £40 for a basic rate taxpayer giving a total effective rate of 44% – and an effective rate of 48% and 49% for higher rate taxpayers.
However, on a death after 75, there is now a restriction which denies the credit for the IHT paid by the pension fund. You can get credit for the IHT if you pay it personally – but that is not much help. It leaves the pension fund with £1,000 to pay out and not just £600. That results in income tax of £120 (i.e. total tax of £520 which is 52%), or £240 (total tax £640 which is 64%) or £270 (total tax £670 which is 67%).
Anybody over the age of 75 who has not yet drawn their pension is likely to regard this as a tad unsatisfactory. Having followed the rules scrupulously for 50 years in saving for his pension (which is supposed to be a Good Thing), he now finds he is going to lose two thirds of it because the Treasury has changed the goalposts.
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