Families are facing an inheritance tax double-whammy because of rising house prices and the raid on pensions. More than 16,000 estates that will be worth more than £2 million by 2030-31 will be caught out by the little-known inheritance tax trap that strips estates of their tax-free allowances.
Most people can pass on £325,000 of their estate tax-free when they die — £500,000 if they leave their main residence to a direct relative and their estate is worth less than £2 million. Everything left to a spouse or civil partner is inheritance tax-free and they can inherit one another’s allowances, meaning a couple can pass on a total of £1 million.
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Estates worth more than £2 million start to lose the extra £175,000 residence nil rate band at a rate of £1 for every £2 of the estate’s value above £2 million. It is wiped out entirely at £2.35 million for a single person, or £2.7 million for a couple.
It’s a tax trap that more families are expected to be caught out by when pensions become liable for inheritance tax from April 2027, under changes announced by the chancellor, Rachel Reeves, in her 2024 budget. At the moment you can pass on a pension pot inheritance tax-free, and if you die before you are 75 your beneficiary will not have to pay income tax on withdrawals.
An estimated 5,613 estates will be valued above £2 million by the 2027-28 tax year, and this will rise to 16,000 by 2030-31, according to the wealth manager Quilter.
By comparison, 3,620 of the estates that were liable for inheritance tax in the 2022-23 tax year were worth £2 million or more, according to HM Revenue & Customs.
Pension pots are often more valuable than the family home, meaning that many more grieving families will be pushed into paying inheritance tax. Sean McCann from the insurer NFU Mutual said that at the moment a £2 million estate of a single person with a £500,000 pension on top would accrue an inheritance tax bill of £600,000. From April 2027 the bill would rise to £870,000.
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“Including pensions in the inheritance tax net could mean the loss of the tax-free allowance on the family home,” McCann said. “Coupled with the potential for an income tax charge on the pension beneficiaries, this will be a triple blow to many.”
Wealth managers and pension experts have said that constant tinkering to pension tax rules, such as making pots liable for inheritance tax, puts savers off putting away money for retirement.
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Alex Pugh from the wealth manager Saltus said: “Many see pensions as a stable and tax-efficient way to provide for retirement and pass on wealth, but bringing pension pots into the scope of inheritance tax fundamentally alters that calculation, particularly when combined with the tapering of the residence allowance once estates exceed £2 million.
“The big danger here is not just the tax bill itself but the erosion of savers’ confidence. Persistent tweaks to pension rules, alongside headline-grabbing tax changes, risk undermining trust in a system designed to encourage long-term saving and reduce dependence on the state pension. Ultimately, when people see the goalposts moving repeatedly they begin to question whether locking money away for decades is worth the uncertainty.”