A new pensions ‘death tax’, covering the treatment of inherited pensions by HM Revenue & Customs (HMRC), appears to be on the way.
Documents published by the government this week about the abolition of the lifetime allowance include a proposed change which has not previously been discussed publicly by ministers.
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Inheriting pensions: what is changing?
The issue is around inheriting a pension from a loved one who passes away before they reach the age of 75.
Under the current setup, the beneficiaries are able to inherit pensions paid as an income when the saver dies before 75 without having to pay any income tax or inheritance tax. If the saver dies after reaching 75 then the inherited pension is taxed in the same way as income.
This arrangement appears to be changing though, as part of the government’s move to ditch the lifetime allowance, as announced at the Budget earlier this year.
In the policy documents for the removal of the lifetime allowance, the government also sets out the change to how inherited pensions will be taxed when taken as income rather than as a lump sum.
The document states: “Individuals will still be able to receive the benefits .. but the values will no longer be excluded from marginal rate income tax under [the Income Tax (Earnings and Pensions) Act 2003], with effect from 6 April 2024.”
This would mean that the only way to avoid tax would be to take the inherited pension as a lump sum, leaving the beneficiary to decide how to invest and manage this money over time.
Government must clarify ‘death tax’ plans
The move was described as “creating a new pension ‘death tax’ where someone dies before age 75” by Tom Selby, head of retirement policy at AJ Bell.
He said that doing so makes “little sense” and may push more beneficiaries to take a lump sum, when instead an income from the inherited pension would better suit their needs.
“Or encouraging the member to take their pension benefits earlier than planned to avoid their loved ones paying income tax. It also risks causing a political firestorm for the government and undoes much of the simplification benefits associated with ditching the lifetime allowance,” he continued.
Selby also emphasised that this new ‘death tax’ is not specified in the draft legislation which has been tabled, and called for the government to clarify what is going on urgently.
This was echoed by Steve Webb, the former pensions minister and director of pension consultancy LCP, who argued it would be “totally unacceptable” for such a change to be made ‘“through the back door” rather than announced publicly.
He continued: “For the last eight years, people have known that if a loved one died under the age of 75, they could inherit an untouched pension pot free of all tax. The money could sit in a drawdown account, being invested and growing, and would be a source of tax-free income whenever needed. This tax advantage risks being abolished by next April if these new proposals are implemented.”
Removing disincentives
The government has not commented directly on the proposed change.
A spokesperson for HMRC told Moneyweek that it wanted to keep “15,000 experienced people in work” and that the lifetime allowance had been “disincentivising them from working”.
They continued: “We look forward to working with stakeholders over the coming weeks to help us craft the legislation which will ensure that our historical pensions tax cut delivers the right results for savers and the economy.”
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