The Pension Double Tax Trap:

Could your family pay both Inheritance Tax and Income Tax?

 

For years, one piece of retirement planning advice was almost universal:

Spend your savings.

Spend your ISAs.

Leave your pension until last.

It wasn’t just good investment planning. For many people, it was also good tax planning. From April 2027, however, that long-established strategy may deserve another look.

Why did advisors recommend leaving pensions until last?

There was a good reason. Unlike most other assets, unused pension funds generally sat outside your estate for Inheritance Tax purposes. If you didn’t need the money, leaving it invested often made perfect sense. Meanwhile, you could spend assets that would otherwise have formed part of your taxable estate. It was a sensible strategy under the rules that existed at the time.

The problem is… The rules are changing. Where does the “double tax” come in? This is where things become more interesting. From April 2027, most unused pension funds will generally form part of your estate for Inheritance Tax purposes. That means, where an estate exceeds the available allowances, Inheritance Tax could become payable. But that’s only part of the story.

Depending on your age when you die and how your beneficiaries choose to take the pension, Income Tax may also come into the picture. These are two completely separate taxes. One doesn’t replace the other. In some circumstances, they can both apply.

Age 75 still matters

One thing that hasn’t changed is the importance of age 75.

Broadly speaking: If you die before age 75 Beneficiaries can usually receive pension income or lump sums without paying Income Tax, provided the relevant conditions are met. However, from April 2027, the pension itself may still be included when calculating your estate for Inheritance Tax.

If you die after age 75 – The pension may first be taken into account for Inheritance Tax. Then, when beneficiaries withdraw money from the inherited pension, those withdrawals are normally subject to Income Tax at their own marginal rate. That’s why some commentators have described this as a double tax.

It’s important to remember that the Income Tax isn’t charged on the original pension value. It applies to the inherited pension benefits received by the beneficiary under the existing pension tax rules. The combined effect, however, can still significantly reduce what ultimately reaches the next generation.

An example: Let’s keep the numbers simple.

Imagine a parent passes away after age 75, leaving a £100,000 pension pot to their adult child, who is a higher rate (45%) taxpayer who withdraws the entire fund immediately. For the purpose of this example let’s assume the parent’s estate already exceeds the Inheritance Tax thresholds and no additional reliefs or exemptions apply:

1. The Pension Pot: £100,000
2. Minus 40% Inheritance Tax: -£40,000
3. The Remaining Balance: £60,000
4. Minus 45% Income Tax (on withdrawal): -£27,000
5. What the family actually receives: £33,000

This is deliberately illustrating a “worst case” scenario of the amount of tax payable (67% of the pension pot goes to HMRC). In reality many families would pay significantly less because the beneficiary pays basic rate (or no) tax, there are multiple beneficiaries, withdrawals are spread over many years and any available allowances and reliefs can be used to reduce the overall tax liability. 

Fathom Insight

The phrase “double taxation” can sound alarming.

In reality, the amount of Income Tax paid after inheriting a pension depends on who inherits it, their other income and when they decide to withdraw the money.

For many beneficiaries, the Income Tax could be much lower than the headlines suggest.

That’s why inheritance planning isn’t just about reducing tax. It’s about making sure the right assets pass to the right people at the right time.

Does this mean pensions have become a bad place to save? Absolutely not. This is perhaps the biggest misconception we’ve encountered. Pensions remain one of the most tax efficient ways to save for retirement. You still benefit from:

• Income Tax relief on contributions (subject to the rules).
• Tax efficient investment growth.
• A tax-free pension commencement lump sum in many cases.
• Flexibility over how retirement income is taken.

The pension itself hasn’t suddenly become unattractive. What’s changed is how we might think about leaving large unused pension funds to the next generation. So, should you still leave your pension until last?

Maybe… Maybe not.

The answer depends on your circumstances, that’s probably not the answer you were hoping for, but it’s the honest one. For some people, preserving the pension will still make perfect sense. For others, it may now be more tax efficient to draw a little more income from the pension during retirement while preserving other assets.

There is no universal answer. The right strategy depends on your:

• Retirement income needs
• Health
• Other assets
• Family circumstances
• Likely beneficiaries
• Wider estate planning objectives

That’s why retirement planning and estate planning have become much more closely connected than they were before.

Fathom Insight

The question isn’t: “How do I avoid tax?” 

It should be: “How do I make sure my family receives as much of my wealth as possible?”

They’re not always the same thing.

Fathom’s View

Tax legislation changes, your goals usually don’t. The important thing isn’t reacting to every Budget announcement. It’s making sure your financial plan continues to work for you and your family.

The Bottom Line: “Double Taxation” makes the headlines but it doesn’t tell the whole story. For some families, the combined impact of Inheritance Tax and Income Tax could be significant. For others careful planning and simply giving some thought to who inherits your pension could make a considerable difference. 

The rules have changed. 

Good planning hasn’t.

Three questions worth asking yourself: 

1. Who have I nominated to inherit my pension? 
2. Are they likely to be a higher rate taxpayer when they inherit (or withdraw)?
3. Does my retirement income strategy still make sense after April 2027?

Coming next…

Many people assume the only asset affected by these changes is their pension.

In our next article we’ll explain why that isn’t always the case and how your pension could unexpectedly increase the Inheritance Tax bill on your family home by affecting the Residence Nil Rate Band. It may be one of the least understood consequences of the new rules.

Let’s Talk

Tax legislation changes. Your financial goals probably don’t. If you’re unsure whether your retirement strategy is still the right one under the new rules, contact us and we’d be happy to review your existing plans and explain the options available in plain English.

Sometimes, the best place to start is with a confidential chat over coffee.

Important: This article reflects Finance Act 2026 and the HMRC guidance available at the date of publication. The changes apply to deaths occurring on or after 6 April 2027. Further secondary legislation and HMRC guidance are expected before implementation. Tax legislation is subject to change, and the application of tax rules depends on individual circumstances. This article is provided for general information only and should not be relied upon as personal financial or tax advice.