Inheritance tax on pensions - would this be an effective tax rate of up to 67%?

There’s a massive incentive, I put £6000 in a pension last week, it’s already worth £7500 as the pension company claimed the basic rate tax and then I will claim the higher rate tax through my tax return which is another £1500, plus I get to keep my child benefit, so it’s already worth £9000 even ignoring the child benefit compared to if I’d put the money in an isa it would still be at £6000. Ok I will have to pay tax when I take the money out but I will do this when I am retired and not in higher rate tax so I will pay basic rate tax on the pension income whilst having got higher rate relief on the way in. Pensions aren’t supposed to be inheritance tax tools they are for saving and making providing for your own retirement.

But with ISAs you can take that money out and spend it whenever you need it. There is no longer the same incentive to lock money away out of reach in a pension until you’re 57.

We will actually probably now retire earlier.

Which is the same as any other asset that is subject to iht it’s paid by the estate, but the estate doesn’t pay the income tax it’s the beneficiaries if they take the money out. If the person had taken the money out of the pension before they died they would have paid tax on it, that money would then be in their estate and charged to IHT. Why should the fact it’s a pension mean it’s not subject to IHT or income tax?

One thing we did years ago was start an insurance policy on the second life (whoever dies second and last out of the two parents), written in trust with our children as beneficiaries. The premiums are reasonable as we started early. They will receive a lump sum falling outside our estate so no IHT. But they will use the money to pay towards the IHT bill for the house and other assets such as ISAs and pensions.

Tax has already been paid on the money paid into ISAs though

There are a many over 50 year olds in the gym and running marathons. Many people are not worn out and perpetuating this type of thing makes it hard for over 50s and 60s to get jobs.

A few may have illnesses but many are very fit especially if they don’t drink, smoke and are not particularly over weight.

Yes with the hope that it gets relief at a higher rate than it is taxed on when it comes out. Your beneficiaries don't pay IHT. Your estate does. And as others have said that'll now be the point at which it (any undrawn balance) is taxed.

But a pension was never intended to be a vehicle for tax-free inheritance. That's the point. The tax-free element of pension savings was intended to be for your pension - not an inheritance for your children/beneficiaries.

It's no more "double-taxed" than non-pension investments, because it was not taxed before it went into the pension fund. Adding IHT brings it into line with other inherited assets, taxing on withdrawal at the marginal rate is then the missing tax that wasn't paid on it originally.

I think it is fair that the tax relief on pensions allows you to built a suitable fund for your own retirement from your earned salary. Governments should be encouraging saving so that pensioners can fund themselves rather than being funded by the state. The state pension is a separate but sensible part of a government's duty. It makes no sense for this fund to be exempt from inheritance taxes - it is no different to other inheritance assets - once it has been used for its purpose.

but you pay tax when you or whoever inherits draws the money out (apart from tax free lump sum)

You are absolutely right.

Subjecting pensions to inheritance tax will accelerate The Great Wealth Transfer by asset rich parents. They will simply spend their pension on retirement instead and gift their ISAs and other assets to their children early and hopefully live 7 years more to keep 40% away from the tax man. This will widen the gap between children who are the fortunate beneficiaries of the transfer quite early on in their lives v. those who do not have such gifts ever. How dispiriting it must be to graduate from the same class at uni to see your contemporary have a house, car and nice holidays and gaining experience doing free internships almost right away. In my time, you would be middle-aged to get the bulk via inheritance. Not any more.

It is also true about sapping the productivity of the 50+. I know as I am one of them. There is no longer any incentive to build up my pension, so I can work fewer hours and take on a less demanding job to plateau into retirement. It is tempting.

Most people don’t buy an annuity with their DC pension these days. They just take the natural investment income from it or spend it down, or both.

I don’t see how subjecting people to 67% tax is “closing a loophole.” It’s just a cackhanded action by people who didn’t properly think through how the new tax would interact with an existing one, and are now too embarrassed to admit their mistake.

Yes, assuming the dead couple owned a house so benefit from the full £1m IHT allowance, you are correct.

Er no it isn't. You get basic / higher rate relief on the contributions. (I.e.) Grossed up

With regard to the over-50's, those who have an interesting and engaging job sitting in an office are very likely to want to continue working, at least part-time, well into their sixties or longer.
These 'professionals' are the ones most likely to get inheritances.

People from poorer backgrounds, where inheritance is far less likely, are also the ones more likely to be in physically demanding jobs, such as nursing, retail, care-work, building trades, mechanics, etc. Many of these people are worn-out by age 50 and just counting down the years to their state pension.

So I don't think that inheritance has much effect on work-force participation for 50-somethings.

@blueshoes, if the consultation paper goes through, anything above the IHT threshold will be taxed at 40% then the beneficiary will be taxed at their marginal rate - an even greater incentive to pass on assets early.

There’s been a lot of talk about inter generational unfairness on inheritances. This isn’t going to remove that. It will just bring it forward as people give away assets early. Those kids lucky enough to be born into families who have built up (or retained) wealth will just receive it earlier and as you say, it will dampen ambition.

This policy will also exacerbate the productivity problem of the over 50s. Why bother working if you have enough money to see you out and anything above that will be taxed excessively? Has no-one heard of the Laffer curve in the Chancellor’s office? Ok, the numbers of people here may not be in the hundreds of thousands but they will be the highly skilled and/or entrepreneurial. We should be encouraging workforce participation for the over 50s for so many reasons.

This.

The generation that have already built up their pension pots will have to spend it to avoid the 40% going to the tax man on their death rather than to their dcs.

The dcs having received their inheritance early will be disincentivised to work to save up into their pensions any more than they need for retirement, which is less due to their early inheritance. So this policy has a knock on effect on future generations' ambition.

It is not completely 'lucky' that some people had the deposit to buy property at the right time. They could have lived in lousy accommodation or worked long hours in unsocial jobs to save up. There is no longer the same incentive to do so for the dcs. So fewer higher rate tax payers to fleece. The money tree gets smaller.

But that is Labour's plan. Levelling out to a lower standard overall.

It's unclear to me how this will work - at the moment, if I understand correctly, most defined contribution pensions are passed on free of inheritance tax to beneficiaries, but if the person who died was over 75, then any sum taken out of the pension by the beneficiary is added on to the beneficiary's income and taxed at income tax.

If you're over 75 and there's a significant sum (significant for IHT purposes) in your pension pot when you die that hadn't been converted to an annuity, then what exactly was the purpose of the investment vehicle that you were putting all that tax-free income into?

The pension IHT exemption was a sizeable tax loophole for the wealthy that had been highlighted by several commentators as long overdue closing.

I’m confused.
A DC pension can be passed on to your wife/husband without IHT, as when you die, there is no limit or tax between spouses.
IHT is for the children of the surviving spouse, providing the estate is more than £1m.

Am I correct?

But the pensioner taking money out of the pension to use it all up will pay tax at their marginal rate which is exactly thr same situation as the person who inherits having to take tax out of their pension. It will reduce the overall value of the estate as you are replacing pension scheme value with cash which is less fhe tax you pay on pension. The idea of downsizing is that you convert part of the house value into cash and you don’t pay any tax as it’s your principal primary residence so your estate value doesn’t change at the date of sale, you are just changing a house for cash of the same value, however the cash you can then give away more easily and hope you survive long enough

Yes I am idealistic - it is a better way to live than being devoid of ideals.

Giving lump sums to offspring before death requires that the parent be generous enough to give it away early, rather than clinging on and trying to time it 7 years before death.

But it is still unfair to those who don't have wealthy parents. C'est la vie, life is not fair. All a government can do is try and level the field a bit.

This. Taxing the rich, and the rich don't like it up 'em.

these changes will hit our parents (ie us!) potentially quite hard.

BUT oh my god, I so so wish both sets of parents had downsized a decade ago, and dealt w their own stuff. They are way too old to move now and we have the prospect of in one case potentially spending years sorting things out. I think that if the financial consequences of staying in a FAR too big house had been clear a decade ago, my siblings and I would not be faced w the mess our parents will leave us to deal with.

Any policy changes that encourage the old into right-sized homes sounds good to me.

So I am right that this means older people instead of sitting on savings are more likely to either spend it or gift it to younger generations? In which case either imagine this will give the economy a bit of a boost?