When people ask if I’m worried about inheritance tax, my instinctive answer is no. With five sisters, any family inheritance is sliced more ways than a birthday cake, and not a very big one at that.
But that doesn’t mean I wouldn’t like the option to pass on more of my own hard-earned wealth to my children one day. Like most parents, I make financial decisions with their future in mind. Surely that is something the tax system should encourage, not punish.
According to the latest figures released by HM Revenue and Customs, the Treasury received £5.2 billion in inheritance tax receipts between April and October this year. This is no small change, and is £200 million more than in the same period last year. What was once a niche tax affecting the very wealthy has quietly crept down the income ladder. Frozen thresholds mean that more modest families are now getting caught in the net.
• Families face £3m inheritance tax bills on ‘failed gifts’
For years the one tax shelter that remained untouched was for pensions. But from April 2027 that’s changing. Most pension funds will become part of an estate for inheritance tax purposes. This is expected to raise about £1.4 billion a year once fully in force and will come with profound emotional and behavioural consequences.
This change has been widely sold to us by the government as “removing distortions” and preventing pensions from being used as an inheritance vehicle. However, for millions of savers pensions aren’t an inheritance vehicle at all, but rather a safety net for retirement.
To my knowledge, it was never made clear why pensions were originally excluded from inheritance tax, but I suspect the practical consequence was to encourage people to keep their long-term savings intact, ready for later life or care costs.
• Dan Neidle: We are taxing all the wrong people
Now that logic looks set to turn on its head. Leave your pension untouched, and your heirs face a tax bill, but spend it early, and you risk outliving your savings. Either way, the time bomb is waiting to detonate.
If people outlive their savings, this will come at a massive cost to the Treasury in care costs. The state already spends tens of billions each year on long-term care, with the average private care costs now at about £1,267 a week. Taxing pensions on death risks weakening the incentive to keep those funds available for old age, and could serve to make retirement planning for families far more complicated.
There is also the issue of widening the gap between those with defined benefit (DB) pensions, as is often the case for those in the public sector, and the millions with defined contribution (DC) pots. DB members can’t pass their pension on as a lump sum, but they get a secure income for life, often worth far more than DC incomes. They can also pass on other assets as they earn.
DC savers, meanwhile, are encouraged to be flexible, self-reliant and responsible, only to find their prudence punished in death. This divide between public sector pensions and “the rest of us” is already causing friction.
The same sense of unfairness runs through every inheritance tax conversation I have. One local farmer’s wife told me that their small cattle holding, which has been passed down through generations, won’t survive the tax bill when her father-in-law dies. The next generation will have no choice but to sell after the government’s plan to remove agricultural relief.
• Labour MP suspended as dozens rebel over farm inheritance tax
Contrast that with the country’s largest estates and it’s clear that the structure of our inheritance tax system ensures that those with the best advice, and the most complicated trusts, can navigate the tax largely unscathed, while small family businesses, farms and homes bear the brunt.
The Institute for Fiscal Studies has repeatedly warned that abolishing inheritance tax altogether would overwhelmingly benefit the richest, and of course, it is right. But that doesn’t mean that the present system is fair. The challenge is to design a system that feels even-handed; taxing unearned windfalls without penalising the kind of intergenerational planning that keeps families afloat and reduces pressure on the state.
Because surely that is the point. When I save diligently, I’m not doing it to deprive the Treasury, I’m ensuring I and my children don’t become a burden to it. Should one of them become incapacitated, surely I should be able to leave them with a financial cushion without the state taking 40 per cent of it.
Dragging pensions into the inheritance tax net is expected to raise £1.46 billion for the Treasury each year. But at what cost?
Antonia Medlicott is the founder of the personal finance site Investing Insiders