Lord Davies of Brixton recently, and very kindly, bought me a cup of tea and had a chat with me about IHT. I think he quite clearly sets out the government’s rationale for applying IHT to pension savings and talks us through his concerns. Here is a record of our chat!
PG: Why is the government introducing inheritance tax on pension savings now?
Lord Davies: The government wants to make sure pension savings are used for retirement, not as a way to pass on wealth tax-free. Pensions were never meant to be an inheritance tool. So, they’re introducing inheritance tax on certain pension savings to bring them in line with other assets passed on at death.
Over time, pensions have become increasingly attractive for inheritance, which was never the intention. Back in 2006, under the ‘A-Day’ reforms, the inheritance tax position didn’t really change much because people still had to buy an annuity at age 75. That rule ensured pensions were focused on providing retirement income rather than being preserved for inheritance. But in 2011, that requirement was scrapped, meaning people could leave their pension savings untouched indefinitely and pass them on instead.
At that point, the government decided not to apply inheritance tax to those inherited pensions, but they did introduce a 55% income tax charge to discourage pensions from being used purely for inheritance. If someone died at 75 or older, their beneficiaries had to pay this 55% tax on any inherited pension savings. The idea was that this tax charge roughly mirrored the inheritance tax and income tax that would have been paid on other types of assets.
Then in 2015, pension freedoms made it even easier for people to pass on their pensions over multiple generations, making them far more attractive as a wealth transfer tool. The 55% tax charge was scrapped, and instead, pensions could be inherited tax-free if the original pension holder died before 75. If they died at 75 or older, the beneficiary would pay income tax at their own rate when they withdrew the money. This shift made pensions a significantly more appealing way to pass on wealth.
More recently, the abolition of the Lifetime Allowance in March 2023 removed the cap on how much tax-relievable pension savings a person could accumulate. That made it possible for people to amass large pension pots and pass them on tax-free, which was never how pensions were supposed to work. This change is effectively closing that loophole.
PG: So, what concerns do you have about the policy?
Lord Davies: The biggest challenge is defining what counts as ‘unused pension savings’. In most cases, it’s obvious, but there are grey areas that need more thought. For instance, if someone is gradually drawing down their pension but dies before using it all—should the remaining balance really be considered ‘unused’ and taxed? And what about pensions with guarantees, where payments continue to a spouse or dependent? These aren’t always clear-cut situations, so we need proper guidance to ensure fairness.
I also think this could be particularly unfair for people with smaller pension pots. If someone only has around £30,000 in savings, taxing that doesn’t feel right. There should be an exemption for smaller amounts to avoid penalising those with modest savings.
Another area that needs careful handling is the administrative burden. Pension schemes shouldn’t be responsible for working out and deducting the tax—that should be the executor’s job, just like with other inherited assets. Asking pension providers to handle tax calculations adds unnecessary complexity and extra administrative costs.
PG: Do you have any concerns about how guaranteed lump sum payments are treated?
Lord Davies: Yes, this is a tricky one. If a pension scheme continues to pay out a guaranteed income to a surviving spouse, that’s generally considered part of the pension arrangement and isn’t taxed in the same way. But if the scheme instead pays out a lump sum, that lump sum could be treated as part of the deceased’s estate and taxed.
That’s inconsistent. In both cases, the payments are serving the same purpose—supporting a surviving spouse or dependent—but they’re taxed differently. That’s not fair. If the government is going to tax lump sums, they need to make sure people aren’t penalised just because of how their pension scheme structures the payments. Otherwise, schemes and individuals will start making financial decisions based on tax rules rather than what’s best for their needs.
PG: Do you think the policy will achieve its objectives?
Lord Davies: One of the government’s main goals here is raising revenue, and yes, this will bring in more tax. Advisers will likely change their guidance, warning people that pensions aren’t a tax-efficient way to pass on wealth anymore, which will put some off from using them for inheritance planning.
But there are concerns about how complicated it will be to administer. The government needs to introduce some simplifications—especially to make sure people with smaller pots don’t get caught up in unnecessary bureaucracy.
PG: Will this change affect overall pension savings?
Lord Davies: It’s possible that fewer people will see pensions as a good place to stash extra wealth beyond what they need for retirement. Some might shift their money into ISAs or other savings. But pensions are still a very tax-efficient way to save for retirement, so I don’t think we’ll see a huge drop in pension savings overall.
The real issue isn’t how much is saved in pensions, but how that money is used. The government wants to make sure pension savings are actually being used for retirement, not just passed on tax-free.
PG: Any final thoughts on this policy?
Lord Davies: This is about getting pensions back to what they were meant for—funding retirement, not inheritance. It will cause some disruption, but it’s closing a loophole that’s been growing over the past decade. The key thing will be how it’s implemented—whether they bring in exemptions for small pots, how they define ‘unused pension savings’ and who’s responsible for dealing with the tax. If they get those details right, this policy can work without causing unnecessary complexity or unfairness.
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