Labour’s plan to tax inherited pensions could generate an estimated £40billion for the Treasury over the next two decades, far exceeding official estimates, according to new analysis.
The tax measure, set to take effect from April 2027, will bring pension savings into the inheritance tax (IHT) net for the first time. Calculations by pensions consultancy LCP suggest the revenue could reach more than £3billion annually at its peak.
The dramatic increase is largely attributed to a surge in pension transfers during the 2010s, following the introduction of pension freedoms. Britain’s largest pension companies have warned that the “ludicrous” tax grab will erode hard-earned pension savings and discourage retirement saving.
The Treasury expects the measure to raise £640million in its first year of implementation. This would rise to £1.34billion in 2028/29 and £1.46billion in 2029/30, according to official estimates.
However, LCP’s analysis suggests these figures significantly underestimate the long-term impact. The consultancy projects the tax take will climb sharply through the 2030s and beyond.
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The Treasury is set to make £40billion from the inheritance tax raid on pensions
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Their calculations indicate the total revenue could “easily exceed £40billion” over the next two decades. The dramatic difference stems from the lasting effects of pension transfer activity that peaked in the late 2010s.
This surge in pension transfers followed the introduction of “pension freedoms” in April 2015. These reforms gave savers the option to convert defined benefit schemes into defined contribution retirement pots.
Over 100,000 transfers were made in the five years following the changes. The peak of transfer activity occurred in 2017/18. Six-figure transfer values were common during this period. Activity dropped significantly after this peak, following the implementation of stricter rules around financial advice.
The surge in transfers was partly driven by limitations in defined benefit schemes. These schemes typically only allow around 50 per cent of the pension to be passed to a surviving spouse.
The Chancellor unveiled the changes to inheritance tax rules during her Autumn Budget
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This restriction led many savers to transfer their pensions specifically to ensure any unspent funds could be inherited by their family. Most people who transferred their pensions were in their late 50s during the late 2010s.
As this generation ages and passes away, their transferred pension funds will become subject to inheritance tax under Labour’s plans. LCP’s modelling suggests the tax take from transferred defined benefit funds alone could reach £3billion annually.
This figure excludes additional inheritance tax revenue from defined contribution pots not originating from defined benefit schemes. The impact is already visible in current tax receipts, with inheritance tax revenue reaching £6.3billion between April and December 2024.
For context, this represents a £600m increase compared to the same period in 2023. Under current rules, inherited pensions from someone who died aged 75 or over are subject to income tax at the recipient’s highest rate.
The new inheritance tax rules could result in some higher-rate taxpayers facing marginal tax rates of up to 90 per cent on inherited pensions. Tim Camfield, senior consultant at LCP, said: “Applying inheritance tax to pension balances could prove to be a real gold mine for the Government for many years to come.”
He added: “The surge in defined benefit pension transfer activity which we witnessed in the late 2010s will dramatically increase the number of people whose estate includes a significant defined contribution pension balance.
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“Either way, as the defined benefit transfer generation gets older, the Government will start to see a multi-billion pound revenue stream from the income tax or inheritance tax on their pension pots.”
A Treasury spokesman rejected LCP’s projections, stating: “We do not recognise these figures.” The spokesman explained that Government costings are based on actual inheritance tax data. These figures are certified by the independent Office for Budget Responsibility, which forecasts over a five-year period.
“We continue to incentivise pensions savings for their intended purpose – of funding retirement instead of them being openly used as a vehicle to transfer wealth,” the spokesman added. “Most estates will continue to pay no inheritance tax after these changes.”
Inheritance tax is currently charged at 40 per cent on estates above the nil-rate band of £325,000. Accountancy firm RSM warns that higher-rate taxpayers could face marginal tax rates as high as 90 per cent on inherited pensions
