A simple solution to inheritance tax

We get so caught up in fiddling with our a tax system. But as this simple idea for reforming inheritance tax shows, all we really need to do is simplify it.

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When the benefits from the pots were withdrawn, they would then (obviously) be taxed at the marginal income tax rate of the recipient.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.

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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.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.