The government has cracked down on a potential loophole in pension funds that could have allowed wealthy individuals to avoid huge sums in inheritance tax.

Rules introduced to accommodate religious groups such as the Plymouth Brethren, who did not want to receive an annuity, had created the possibility of wealthy individuals keeping their pension pots as lump sums and not drawing an income.

That in turn could have meant pension pots passing through families on death, avoiding a 40% inheritance tax charge. Gordon Brown announced that the loophole will effectively be shut, by introducing a 70% charge on the pot if passed on.

Patrick Stevens, Ernst & Young tax partner, said the move was fair as the government had not forced individuals to buy an annuity and could therefore still retain control of their pension fund. ‘The government isn’t forcing you into the arms of the insurance providers,’ he said.

Pension fund holders over 75 years old will have to draw 65% from their fund based on what would normally be drawn from an annuity, but Stevens said this move was ‘a modest proposal’.

The changes will be effective from 6 April 2007.