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When the benefits from the pots were withdrawn, they would then (obviously) be taxed at the marginal income tax rate of the recipient.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

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