The number of families using a little-known loophole to beat Rachel Reeves‘s inheritance tax raid has nearly tripled, new data has shown.
In a bid to reduce their death duty payments, families are increasingly transferring money to their children via ‘gifts out of surplus income’, new HM Revenue & Customs (HMRC) figures obtained via Freedom of Information laws have revealed.
The amount of money transferred under such loophole increased from £52million in 2022-23 to a staggering £144million in 2023-2024, the Telegraph has reported.
The niche rule grants taxpayers the ability to give away unlimited funds without inheritance tax provided that the gifts do not diminish their quality of life and they derive from an individual’s income, rather than from savings.
In order to be exempt, gifts must be made more than seven years prior to death. However, if a family can prove that the payments are made on a regular basis then that money is automatically made exempt and does not have to abide by the seven-year rule.
Under the Chancellor’s maiden budget in October last year, it was announced that tens of thousands of grieving families were set to face a new death duty on pensions and also have to pay the dreaded 40 per cent charge for the first time.
Inheritance tax: In a bid to reduce ‘death duty’ under Chancellor Rachel Reeves’s new reforms, families are increasingly transferring money to their children via ‘gifts out of surplus income’
From April 2027, pension pots will be included in the value of a deceased person’s estate and subject to inheritance tax.
Currently, inheritance tax is levied on wealth bequeathed at death or given away in the years beforehand, above certain thresholds.
You need to be worth £325,000 if you are single, or £650,000 jointly if you are married or in a civil partnership, for your loved ones to have to stump up death duties.
But there is a further chunky allowance which increases the threshold to a joint £1million if you have a partner, own a property, and intend to leave money to your direct descendants.
Once an estate reaches £2million this own home allowance starts being removed by £1 for every £2 above this threshold. It vanishes completely by £2.3million.
Private and workplace pension funds do not currently form part of an estate upon death and have not been liable for inheritance tax.
This means that any remaining money left in a pension upon death can be transferred to loved ones in a tax-efficient way.
But under Reeves’s controversial new plans, families will now face a double tax charge of income tax – if the deceased was aged over 75 – and death duty on inherited pensions.
The Government insists that the change would likely affect up to eight per cent of all estates each year, equating to more than 50,000 families.
Official forecasters have revealed that the Treasury will rake in more than £3.4billion from pension pots in the form of inheritance taxes by 2030, official forecasts reveal.
As a result, Duncan Mitchell-Innes, of TWM Solicitors, told The Telegraph that families are ‘increasingly giving excess income to their loved ones’ in a bid to overcome Reeves’s inheritance tax raid.
Meanwhile, Shaun Moore, of wealth management firm Quilter, told the publication that surplus income gifts are ‘one of the most effective yet underutilised inheritance tax reliefs available’.
He added that it was ‘not surprising’ that families were looking to use new methods of mitigating the incoming tax changes in order to pass on money to younger generations.
The Chancellor’s policy change comes despite warnings from pension experts that the reform is set to throw years of succession planning into disarray, and many savers will be forced to overhaul their plans for passing wealth down to the next generation in order to shield their retirement pots from the taxman.
Baroness Ros Altmann, a former pensions minister, previously warned that the move will penalise younger generations and undermine future pension prospects.
She said: ‘Taking away the ability for savers to pass on their funds as a pension for their offspring is a really bad decision, in my view.
Pensioners will be encouraged to spend their pension while still relatively young, leaving much less to live on if they survive to older age.’
Meanwhile, Mike Ambery, retirement savings director at Standard Life, part of pensions firm Phoenix Group, added that the ‘fundamental’ change means savers will be more likely to draw money out of their retirement savings sooner to shelter them from inheritance tax.
While in 2023 just five per cent of deaths incurred inheritance tax, the Institute for Fiscal Studies (IFS) estimated that this figure would be set to double in 2029.
Isaac Delestre, a research economist at the institute, said: ‘The share of deaths incurring inheritance tax is forecast to go up from 5per cent in 2023 to 10per cent in 2029.
‘That would be a record high since the tax was introduced in the 1980s, and that is partially as a result of the measures introduced yesterday.’
How much can you gift to avoid inheritance tax?
Inheritance tax gift limits haven’t changed since the 1980s
From April 2026, inheritance tax will be payable on agricultural assets worth more than £1million.
Farmers have warned that the changes will force them to sell off land that has been kept in their families for generations to pay the charges.
Financial experts have also warned that top rate taxpayers who inherit pension pots where the deceased was aged over 75 face paying death taxes of almost 70 per cent.
Pensions that are passed on when someone dies will be taxed at 40 per cent above the thresholds, but beneficiaries could end up paying income tax too under the new system.
Rachel McEleney, associate tax director at Deloitte, said: ‘The removal of the inheritance tax exemption appears to result in a double hit on death benefits that do not qualify for an income tax exemption, such as those where people die over 75 years old.
‘Assuming the whole fund is subject to 40 per cent inheritance tax, and the beneficiary pays income tax at 45 per cent on the remainder, this appears to give rise to an effective 67 per cent tax rate on taxable pension death benefits.’
The Government’s official forecasting body, the Office for Budget Responsibility, expects savers to shield more than £2.2 billion from the new death tax by 2030.
The reform will not apply to public sector defined benefit pensions, which guarantee workers an income in retirement.
These pensions typically die with the saver, or only pay death benefits to spouses – who are exempt from inheritance tax – and so there is no fund to pass on to the next generation.
A HM Treasury spokesperson said: ‘Gifting assets is a normal part of the inheritance tax system. Nine in 10 estates will continue to pay no inheritance tax by 2030, and the first £325,000 of any estate can be inherited tax-free, rising to £500,000 if the estate includes a residence passed to direct descendants, and £1 million when a tax free allowance is passed to a surviving spouse or civil partner.
‘The tough but necessary decisions we’ve taken on tax mean we could protect working people’s payslips from higher taxes, invest record amounts into the NHS, defence and other public services while keeping bus fares at £3 and expanding free school meals.’
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