Inheritance tax changes will see public sector escape unscathed while others ‘penalised’

The 40 per cent tax charge will apply to retirement incomes left to loved ones by retirees who used their pension pot to buy an annuity.

However, public sector workers with defined benefit pensions will escape the tax raid entirely.

Those who inherit an annuity income will face inheritance tax from April 2027, while similar income from public sector pensions will remain exempt.

The disparity particularly affects unmarried partners of private sector workers, who do not benefit from the spousal exemption that allows married couples to pass wealth between them tax-free.

Rachel Reeves altered rules so that inheritance tax will be charged on defined contribution pension pots, which are widely used in the private sector

PA

Public sector workers typically receive defined benefit pensions, which cannot be directly inherited.

Instead, these salary-linked pensions allow a reduced rate of income to be passed on to a spouse or dependant, similar to an annuity.

However, unlike private sector annuities, this inherited income from public sector pensions will not be subject to the Chancellor’s new tax plans.

Annuities, which are insurance products commonly purchased with pension savings, provide a guaranteed rate until death.

Some annuity products allow beneficiaries to inherit a lower rate of income after the policyholder’s death.

The new rules mean that while public sector pension inheritances remain tax-free, private sector workers who leave annuity income to their loved ones will face a 40 per cent tax charge.

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Chancellor Rachel Reeves announced the Budget in the House of Commons last month

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This creates what pension experts describe as preferential treatment for public sector workers.

Ian Cook, of wealth manager Quilter, warned the new rules could have “devastating” consequences for dependent partners.

“An annuity is purchased to give a guaranteed income for life. But there are scenarios where someone could be asked to pay a cash contribution to pay an inheritance on an income they are yet to receive,” he said.

Cook added that “private sector pensions are being penalised while public sector pensions are being supported by tax changes.”

Tom McPhail, of pensions consultancy The Lang Cat, highlighted the growing inequality in the system.

He said: Members of defined benefit pension schemes could enjoy preferential treatment.

“And this comes on top of inherent advantages of defined benefit schemes, which these days are primarily enjoyed by public sector workers.”

John O’Connell, chief executive of campaign group the TaxPayers Alliance, criticised the growing unfairness in the pension system.

“Private sector workers are sick of picking up the bill for gold-plated public sector pensions,” he said.

“The problem will only become more unsustainable if action is not taken as the contributions made are barely covering the billions needed to fund them.”

The criticism adds to mounting concerns about the disparity between private and public sector pension treatment under the new tax rules.

A Treasury spokesman defended the reforms against accusations of unfairness, stating: “It is not the case that these reforms favour the public sector over the private sector.”