Thousands of elderly folk are dipping into their pension pots early in an effort to beat Chancellor Reeves expanded death tax, financial experts have revealed.
From April 2026, pensions will be subjected to inheritance tax (40 per cent on savings over £325,000) as Labour looks to pensioners to plug the ‘£22billion black hole’.
It means for someone who has spent their life working hard for a comfortable pension of say £1million, but dies before they can use spend it, will see £270,000 of it go to the Treasury rather than their next of kin.
The plans have sparked a wave of people withdrawing money from their pensions early, a move that is treated as income and taxed accordingly.
Labour has targeted pensioners in their quest to get the nation’s finances back on track
GETTY/PA
For example, if someone with no income withdrew £100,000 from a £500,000 pension, they would pay income tax of £17,432.
If they then died, they would pay £30,000 in inheritance tax, bringing the total tax bill to £47,432.
Someone would do this because if they died with £500,000 in their pension, Reeves’ new inheritance tax would mean £70,000 of it would go to the taxman (40% on anything above £325,000), a significantly higher tax bill.
Nick Nesbitt, of accounting firm Forvis Mazars, explained: “Lots of clients who were looking to save their pension before the Budget are now drawing more income out and accepting higher tax bills.
“The strategy previously was to limit withdrawals to £50,000 a year so you are only paying a marginal rate of 20pc. But people are now raising the yearly income to £100,000 and taking the 40pc tax hit.”
Some pensioners are withdrawing funds from their pension early and taking the income tax hit
PA
However, a leading tax expert has issued an urgent warning to people considering this option to think again.
Andrew Gosselin, personal finance expert, said: “Tapping into a pension to cover an inheritance tax bill seems like an easy way to solve the problem, but it usually ends up being an expensive mistake.
“The moment you withdraw that money, you’re hit with an income tax charge- potentially pushing you into a higher tax bracket for the year.”
If you already earnt say £40,000 a year from a job or other investments, you would be paying £5,486 income tax as a basic rate taxpayer (20 per cent).
Withdrawing £100,000 from your pension early would push your income up to £140,000 for the year, breaching the highest income tax bracket of 45 per cent in Britain, meaning you would pay £49,213in income tax.
As before, if you then died, you would pay £30,000 in inheritance tax, bringing your tax bill for the year to £79,213, more than if you just left it all in the pension in the first place.
Inheritance tax is often dubbed ‘Britain’s most hated tax’
GETTY
“So now, not only are you paying inheritance tax, but you’ve also just handed over a chunk of your pension to the Treasury for income tax. That’s two tax bills instead of one,” continued Gosselin.
“The government benefits in the short run because it collects the income tax right away, but it’s a trade-off.
“People who pull out large sums early shrink their retirement savings, which means they’ll have less taxable income in the future.
“Some could even end up relying more on state benefits later in life. The Treasury gets quick revenue, but in the long term, it may actually cost them more.
“From a financial planning standpoint, using pension money for IHT is usually a bad move.
“Pensions grow tax-free, there are ways to lessen the inheritance tax, and they provide income security for retirement.
“Taking out a big chunk means losing out on compounding growth, and that’s money you can’t get back.
“I’ve seen people regret these withdrawals when they realise they’ve depleted their savings much faster than expected.”
Gosselin, who is lead tutor for Bentley University’s accounting and finance students, then outlined his advice for those considering dipping into their pensions.
“A smarter approach is to use other assets first – cash savings, ISAs, or investments that don’t come with an extra tax hit.
“Life insurance policies set up in trust can also be a smart move, covering the tax bill without forcing you to drain retirement funds.
“If liquidity is the issue, HMRC allows some IHT bills to be paid in instalments, which helps ease the burden without making a costly financial decision.
“The only time dipping into a pension might make sense is if there’s no other choice – if the estate is mostly property and there’s no liquid cash to cover the tax. But even then, it’s worth exhausting every other option first.
“The best move is always to plan ahead. Whether it’s making use of gifting allowances, restructuring assets, or taking out life insurance, there are ways to avoid this situation altogether.
“Pensions are meant to provide long-term security. Using them to pay IHT is rarely the right call.”
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Many Britons are concerned about their pension savings GETTY It comes as Chancellor Reeves scrambles to get the nation’s finances back on track after her bombshell budget failed to spark growth and spooked markets.
The Labour Chancellor raised taxes by £40billion to fund massive spending increases for the NHS and other public services, sparking an exodus of wealth and business confidence in Britain.
One of the major sticking points for business has been the so called ‘jobs tax’, i.e. Reeves’ decision to significantly raise Employers’ National Insurance which, along with minimum wage increases, will make it much more expensive to employ people.
Another has been the decision to slash inheritance tax reliefs for businesses and farms, a move that has been widely slammed for handing an advantage to foreign mega-corporations who will not pay a massive inheritance tax bill very forty or so years.
Family business leaders and farmers have warned the move has already sparked a recession in their respective sectors as both have scaled back investment, cancelled orders, stopped pay rises and laid off staff in preparation for big tax bills.
Aside from businesses and farms, Labour has looked to pensioners to raise revenue, stripping them of the winter fuel payment and subjecting their pensions to inheritance tax.
But OBR forecasts show Reeves’ fiscal headroom has vanished forcing the Chancellor to consider more tax rises in her Spring Statement on March 26.
The Treasury have said they do not comment on speculation around fiscal events.