Over the past few weeks, we’ve had lots of clients asking us about the so-called ‘double tax trap’ after seeing it covered across the financial press.
Some of the headlines suggest families could lose up to 67% of an inherited pension to tax from 6 April 2027. It’s certainly enough to make people wonder whether they should be changing their retirement plans. The good news is that, while the underlying tax changes are real, the headlines don’t tell the whole story.
As we explained in our recent article on the 2027 pension inheritance tax changes, most unused pension funds and pension death benefits will be brought within the value of a person’s estate for Inheritance Tax purposes from 6 April 2027.
The recent media coverage isn’t about another brand-new tax being introduced. It’s about how these new inheritance tax rules can interact with the existing income tax rules that already apply to inherited pensions.
So, what is the ‘double tax trap’?
The phrase ‘double tax trap’ isn’t an official HMRC term. It’s simply a phrase used by the media to describe a situation where the same pension money could potentially be exposed to both inheritance tax and income tax.
Under the current rules, most defined contribution pensions have generally sat outside your estate for inheritance tax purposes, provided the pension scheme administrator had discretion over who received the death benefits.
From 6 April 2027, most unused pension funds and pension death benefits will instead be included when calculating the value of your estate for inheritance tax purposes.
However, the existing income tax rules for inherited pensions remain in place. If you die before age 75, beneficiaries can generally receive pension death benefits without paying income tax, provided the benefits are paid within the relevant timescales.
If you die aged 75 or over, beneficiaries will generally pay income tax at their own marginal rate when they withdraw money from the inherited pension.
It’s this interaction between the new inheritance tax rules and the existing income tax rules that has led to the recent ‘double tax trap’ headlines.
So where does the 67% figure come from?
This is the statistic that’s generated most of the headlines. The widely quoted example assumes:
- The pension holder dies after age 75
- The estate pays 40% inheritance tax
- The beneficiary pays 45% income tax as an additional-rate taxpayer when they withdraw the inherited pension.
Under those assumptions, the beneficiary could ultimately receive around £33,000 from every £100,000, creating an effective combined tax rate of around 67%.
It’s an eye-catching illustration. But it’s also just that – an illustration.
Many estates won’t pay inheritance tax at all. Many beneficiaries won’t be additional-rate taxpayers. Others may inherit pension benefits from someone who dies before age 75.
In other words, 67% is a possible outcome in certain circumstances, not a tax rate that automatically applies to everyone.
Does this mean pensions are no longer tax efficient?
No. This is probably the biggest misconception we’ve seen following the recent headlines.
Pensions remain one of the most tax-efficient ways to save for retirement. They still benefit from income tax relief on eligible contributions
You can also usually take up to 25% of your pension as a tax-free lump sum, subject to the current Lump Sum Allowance and your individual circumstances
What has changed is that pensions are no longer automatically the obvious asset to leave until last simply because they sat outside your estate for inheritance tax purposes. From 6 April 2027, that assumption may no longer hold true for many families
As we explored in our recent article, Is it better to spend my ISA money or pension first?, deciding which assets to draw on in retirement has always depended on your wider financial circumstances. These changes simply mean inheritance tax is likely to become an even more important consideration in that conversation.
So should I start taking more from my pension now?
Not necessarily. In fact, making decisions purely because of a newspaper headline can sometimes create a different tax problem altogether.
Drawing larger amounts from your pension could:
- Increase the amount of Income Tax you pay during your lifetime;
- Push you into a higher Income Tax band;
- Reduce the money available to support what could be a retirement lasting several decades; and
- Mean paying tax sooner than you otherwise needed to.
Pension withdrawals above any available tax-free amount are taxed as income, so taking large withdrawals in a single tax year can move you into a higher tax band.
We’ve already started having these conversations with clients, but the answer is rarely as simple as ‘take your pension earlier.’
Instead, it’s about looking at your retirement income strategy, your estate, your family circumstances and your long-term objectives together.
So what should I do?
For most people, this isn’t a reason to make immediate changes, but it is a good reason to review your plans.
Questions worth asking include:
- Is my estate likely to become liable for inheritance tax once my pension is included?
- Am I still withdrawing my retirement income in the most tax-efficient way?
- Does my estate plan still work under the rules due to come into effect from 6 April 2027
- Are the people I’ve nominated to inherit my pension still the right people?
- Should I revisit the balance between my pension, ISA and other investments?
These aren’t panic questions. They’re planning questions.
Porta’s take
The biggest risk here isn’t the new rules. It’s people potentially making the wrong decision because they’ve been influenced by the press coverage.
We’ve already had clients ask whether they should empty their pension before 2027 or stop paying into one altogether. For most people, neither is likely to be the right answer.
Tax should inform your financial plan, not drive it.
The 2027 changes are another reminder that retirement planning can’t be done by looking at your pension, ISA or inheritance tax in isolation. The most effective strategy comes from looking at all of them together.
If the recent headlines have left you wondering whether your current plan is still the right one, that’s exactly the sort of conversation we’re here to help with.
Important information
This article provides general information only and does not constitute personal financial advice. The information is based on our understanding of current regulations, which may change in future. Decisions about your finances should always be made based on your individual circumstances. If you’re unsure about the suitability of any course of action, you should seek regulated financial advice.
The Financial Conduct Authority does not regulate tax planning, estate planning, trusts or wills.
The value of your investments can go down as well as up, so you could get back less than you invested.
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