A simple solution to inheritance tax

A letter in the FT responding to my thoughts on replacing inheritance tax (IHT) with an income tax on the recipients has what looks like rather a good idea in it. Why not allow pension pots to be transferred free of inheritance tax, says reader Roy Watson.

When the benefits from the pots were withdrawn, they would then (obviously) be taxed at the marginal income tax rate of the recipient. This would allow today’s well-off baby boomers to help the younger generation, but also leave pension money invested “for the benefit of the economy” for longer than would otherwise be the case.

I like this idea enormously, but I would also say that no legislation is likely to be required for it. Why? Right now, pensions can be passed down subject to a tax payment of 55%. However, that’s under discussion and I imagine it will soon be aligned with IHT in general (at 40%).

Once that is done, anyone receiving a pension as an inheritance would effectively be able to make a large percentage of it into tax-free pension savings anyway (as they can with any other inheritance).

Having paid IHT at the moment – or income tax/gift tax under my new system – they can then roll much of it immediately into a pension and get an income tax rebate. You can also roll up your annual allowance (currently £40,000) for three years if you like.

So, say you inherit £500,000 today. £120,000 can go into a pension straight away (assuming you aren’t already saving into a pension), and then another £40,000 can every year after. There is, therefore, already a huge tax incentive to make an inheritance into a pension.

We are constantly tempted to fiddle with our system of taxes and allowances. But more often than not, the answer is surely to simplify rather than to complicate.

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  • Tax slave

    Dear Merryn,

    It is not “we” who are “constantly tempted to fiddle with our system of taxes and allowances”. But those clowns in Westminster who seem to delight in making tax taxing, excruciatingly complex, and beyond the understanding of the common man, with great helpings of fiscal drag and other inequitable consequences. However I strongly endorse your final sentence on simplification, and the thrust of the article.

  • Cicero

    All this talk of IHT. It has always been a voluntary tax. Those that pay it (in the words of the late Roy Jenkins) are “Those who trust HMRC more than their family”.

    The real issue is the overall burden of tax in the UK. As at last November the top marginal rate of income tax was 58 per cent, the highest in the developed world. (It has come down very slightly since). No wonder we are losing mobile high earners with rates like that.

    Traditional UK families pay the highest taxes in the world because Britain is one of only two key economies not to recognise marriage in the tax system (The other is Mexico).

    A typical family with 2 children in which one parent remains at home faces a marginal effective tax rate of up to 73% through a combination of various levies, stealth taxes and loss of benefits. (Research by Christian Action Research & Education). This typical family faces a tax burden that is 42% higher than the OECD average.

    Now compare this to what we actually get for all this tax – precious little. Our State Pension (according to an OECD Review in December 2013) is the second lowest pension replacement for a median earning worker. (Basic +S2P) = 32.6%. Only Mexico is worse @ 28.5%

    But under the forthcoming single tier system the UK income replacement rate will fall to 21%. Even full Auto Enrolment (at 8%) might only bring us to OECD average. (‘Might’ – because of investment risk). And of course our Government’s great panacea is this Auto Enrolment – basically an additional tax.

    The problem is of course manifest – we just don’t have those in Government that can govern. And little wonder – they are for the most part professional politicians, who have run little other than their bath before getting into power.

  • NeutronWarp9

    Nobody likes paying taxes and so what is the solution? Be a happy clapper and call for a few taxes to be abolished: IHT, CGT, business rates, etc. But all that happens – quelle surprise – is that the retained tax rates are increased to maintain or increase the yield from the taxes retained.
    There may be different winners and losers after changes are enacted but essentially you can only tax those that have assets to tax, but this is rather more practical and dare I say fairer than taxing those that have nothing.
    In a similar happy clapper and futile vein, I propose we change back to the Julian calendar so that we can get our purloined days back!

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