Many families now use pensions as a tax-efficient way to pass on wealth to loved ones free of inheritance tax (IHT). If you die before age 75, your beneficiaries may escape income tax on future pension withdrawals, too. These attractive tax breaks make a tempting target as Rishi Sunak casts around for ways to fund his Covid bailouts and plug the huge hole in the nation’s finances.
Taxpayers are dreading yet more hikes as the Chancellor plots his Autumn Budget on 27 October. Now a new threat has emerged that will terrify middle Britain.
Sunak could impose inheritance tax on our pension pots when we die, in a move that could generate a fortune for the Treasury.
Carl Emmerson, deputy director at impartial think tank the Institute for Fiscal Research, has attacked pension tax breaks as “indefensibly generous” and “very, very beneficiant”, and called for them to be reviewed.
He said it was “unfair” to allow families to use their pensions to pass on wealth free of IHT, when they are primarily designed to save for retirement.
Sean McCann, chartered financial planner at NFU Mutual, now fears Sunak could launch a pensions IHT attack.
McCann said: “Earlier this year, the Chancellor froze inheritance tax allowances for five years, a decision that will earn him more money as asset prices rise.
“If Mr Sunak wanted to cast his net further, he could make the bold decision to make pensions liable for inheritance tax, raising significant sums in the process.”
Under current rules, if you die before age 75, you can pass on defined contribution personal or workplace money-purchase pensions to loved ones free of income tax or inheritance tax, provided payment is made within two years of death.
Emmerson suggested the age 75 rule was too generous and Rebecca O’Connor, head of pensions & savings at Interactive Investor, said: “It could be viewed as odd giving heirs a double tax-break when a pension is meant to be for your retirement rather than tax planning.”
If you die after age 75, your beneficiaries will be liable to pay income tax when they make withdrawals from the pot.
There is no inheritance tax liability at any point, even if the total value of your estate exceeds the nil-rate IHT threshold.
This makes pensions a tremendous way to pass on family wealth in a tax-efficient way, and many peoople divert their savings into a pension as a result, O’Connor said.
“The inheritance tax saving by leaving money in your pension rather than an Isa can be substantial if your estate is over the IHT threshold.”
She said IHT benefits apply to defined contribution pension schemes, where your money is invested in the stock market and its value depends on how your investments perform.
People typically cannot pass on defined benefit “final salary” pensions on death, although some schemes make provision for spouses and dependents.
O’Connor said talk of IHT pension tax changes has “opened up a whole can of worms”. “It will cause concern for people viewing that as a major benefit of pensions,” she said.
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Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, said charging IHT on pensions “would go down like a lead balloon with the public and go against the ethos of freedom and choice”.
She added: “Much has been made of the ability to pass on pensions free of IHT and in some cases income tax. Any change risks puling the rug out from under their plans.”
Morrissey said any change to pension death benefits would be seen as an assault on everyone’s hard-earned retirement savings, “not just those with a potential inheritance tax liability”.
Lee Clark, financial planner at wealth manager Brewin Dolphin, said Sunak must avoid doing anything that “de-incentivises people from saving into their pensions”.
“The UK has a savings crisis and as things stand it is only going to get worse,” he said.Internet Explorer Channel Network