Insurance and financial services provider NFU have warned that new rules around IHT coming in next April could see some families facing a 91% charge on pension funds they inherit due to a triple tax hit.

This is because, for the first time, unused pensions will be encompassed in Inheritance Tax (IHT) calculations.

Inheritance tax is levied at 40% on estates after any IHT allowances have been taken into account: currently, everyone is entitled to a £325,000 allowance and they can also benefit from the residence nil-rate band of £175,000.

Married couples are also able to pool their allowances: by sharing their individual allowances of £500,000, between this allows them to pass on up to £1 million to their families without incurring IHT at 40%.

However, for estates worth more than £2m, the residence nil-rate band is gradually eroded at a rate of £1 for every £2 that the estate exceeds £2 million.

NFU Mutual say that the scenario changes radically in April for any married couple with combined assets totalling £2 million and pensions of £700,000, and who are leaving their estate to the survivor on the first death – and subsequently to their family.

How the new rules would affect estates

Pension funds are not currently included in the estate calculations, but when they are it will significantly change the amount payable – potentially wiping out most of the value of the pension fund.

So taking the scenario above, at present the family would pay 40% on the £1m they are inheriting above the £1m total allowance mark: in total, a £400,000 IHT bill on the £2.7m estate, leaving the family with an inheritance of £2.3 million.

However, if the survivor dies after April 2027, pensions are included in the calculation… and this takes the total estate value over the £2 million mark, leading to the erosion of the residence nil rate band.

For an estate worth £2.7m, there would be no residence allowance at all as the residence nil rate band is completely removed once the estate value is at £2.35m.

This means that, as well as paying IHT on the pension fund itself, an additional £140,000 IHT is payable.

Therefore, the IHT bill spirals from £400,000 to £820,000 – equating to an effective tax charge of 60% on the £700,000 pension fund.

And there’s more…

Moreover, if the survivor dies after age 75, income tax would also be payable by the children. The money taken from the pension would be added to their other income, potentially pushing them into the 45% tax band.

In this case, NFU say, an additional £219,326 in income tax would be due, creating a total tax hit of £639,326 (an eye-watering 91.3% of the £700,000 pension fund).

Sean McCann, chartered financial planner at NFU Mutual, said: “The changes from April will mean some families will be hit with a triple tax blow.

“There are steps you can take to mitigate the impact, including ensuring you take your tax-free lump sum before age 75: while it may still be subject to inheritance tax it will avoid an additional income tax charge.”

The other steps he cites include taking regular income from their pensions and gifting out of income – provided this does not affect your normal standard of living.

So how can the RetireEasy LifePlan help YOU avoid paying unnecessary IHT?

If your estate looks as though it will be heading into IHT territory, now is probably a good time to start taking measures to limit the impact.

But how can you be sure you can afford, for instance, to change how much you draw down from your pension or how much you gift members of your family?

The answer is simple: enter your relevant financial data into the RetireEasy LifePlan and it will show you precisely what differences this will make to your assets in the longer term, and how that will impact the amount you can comfortably take during each year of your retirement.

What’s more, you can test out a series of different scenarios to confirm which one gives you the perfect balance!

And if your subscription has lapsed, you can renew it for just a few pounds a month.