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

[LargeDeviation]

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.

Will IHT be on top of this?

Assuming £1M non-pension estate and £1M nil rate band including primary residence/spousal transfer, IHT would leave 60% of the original pension pot - and then that remainder would be further taxed at up to 45% if any money is actually taken out by the beneficiary?

Whether or not you agree with inheritance tax on pensions, surely once the money is taxed (whether at income tax rates or inheritance tax rates) it should not be taxed again to be accessible to a beneficiary?

If Rachel Reeves is proposing double taxation at an effective 67% rate then it would be a major disincentive to pay into DC pensions if you even think your estate could possibly get close to the IHT nil rate threshold.

Surely then you’d be cutting your nose off…. ? If you were saving via your pension in case you needed care home fees, then your Dc wouldn’t get that money anyway. By not doing that in order to avoid IHT, you could end up in some grotty care home.

Inheritance tax always taxes money that has already had tax paid on it, that’s how it works. I pay income tax on my salary so it’s already taxed at 20% or 40% depending on if I’m in higher rate. If i save this as cash it forms part of my estate when I die and will have inheritance tax charged if I’m over the limits, same with any other type of income I get and save

The problem for many is the move as much as the house itself.

If you don't do it early (and when is that exactly?) The whole moving process is very difficult.

And then it's not easy to find a place that doesn't need work doing or shafts you on service charges in the guise they are helping you. My son's is looking at houses at the moment and almost every bungalow that pops up is a doer upper.

Is this personal for you, @JeremiahBullfrog ?

We have been able to save. We give monthly to DCs (without leaving ourselves short), and had hoped they'd get some of our DC pension pots in due course. We may revise our plans now.
We're in a too-big house now and are looking for something more suitable (but we're fussy!). Would love to move and spend some of our hard-earned on removal, flooring, decor, new furniture etc.

Not really.

Capital Gains get wiped out on death.

So my house I literally paid 75k cost, 75k in interest, another 80k in improvements over the years. That, today, would hit my estate at 600k.

So not all 600k has come from taxed income.

MIL is going to start gifting and we are going to take the risk that she (hopefully!) lives 7 years.

Dh is determined not to pay any IHT at all.

But pension money will now be subject to IHT AND income tax for the beneficiaries

I think this won't impact most average people, living in average homes.

A married couple can still leave an estate of 1 mill and not be taxed.

So even a house worth 500k, would leave room for 500k in pensions, savings and investments, which would be a dream for 80% of the population.

This will push many millions of people into the category of having IHT on their estates.

@Notsuchafattynow the £325k threshold has been frozen until 2030. If a divorcee has £50k in an ISA or SIPP and dies it will be taxed at 40% (down to £30k) then another 40% will be taken if the beneficiary is a higher tax payer. £18k left - an effective tax rate of 64%, for an occupant of a modest semi in the north of England (assuming it is worth £325k by 2030 for simplicity). That sounds fairly average to me.

Fundamentally, this seems to stem from a dislike of the idea of saving money and giving it away to the people you love when you die, in favour of spending down your assets frivously and frittering away any margin of safety.

Let me rephrase that for you. It comes from a dislike of people acquiring more wealth than they need, and passing on ever bigger pots to heirs to create multi generational rich dynastic families

Only if they take it out of the pension scheme though if they leave it in there they don’t pay any income tax. The amount in the pension will be enhanced compared to paying into an isa as you get tax relief on the way in. Beneficiaries don’t have to withdraw it all if their circumstances don’t need it, wait until a year their marginal rate of tax is lower

If she leaves the house to a child etc she'll get an additional 175k so £500k before IHT kicks in?

If they have more than a million in assets, then good. They should pay IHT.

I don't get the concern here. If you inherit a pension pot thats free money you've not had to earn. What does it matter if some of its been taxed? You've still been gifted free money.

It doesn't matter if the money get taxed a few times. You don't want big pots of money accumulating to small numbers of people, you want wealth shared so it benefits everyone.

@Notsuchafattynow Why should they? What if they've worked their arse off to get to where they are?

If you've enough in a pension to be able to live through retirement, care costs etc and have a chunk left to pass to your heirs, you're much better off than the average person.

The average DC pension pot at 65 is £194k. That will quickly be eaten up by a 20 year retirement. Very, very few people leave sizeable pension pots in their estates, those that do are wealthy.

I think this is fair as long as they allow IHT to be paid directly from the pension pot. Tax hasn’t been paid on the way into a pension, so should be paid on the way out. Beneficiaries will pay that at the time they choose when they draw the money out of the pension. IHT is on top, just like any other asset at death. You can still leave £1m to your kids and infinite amounts to your spouse tax free, which is plenty. Pensions should be for retirement income, not an IHT planning tool. Yes, people may put more into ISAs instead and the government would be entirely happy with that. They’re capped anyway so most people in the IHT bracket will already be maxing them out each year.

Generally where there are husband and wife with a house worth £350k and kids you will still need an estate of more than £1m for them to pay inheritance tax on your pension. Not many people have that.

the government has estimated that of 238,000 estates assessed, only 10,500 would be affected by the new rules where they were not affected under old rules.

It is more likely to affect those who would have already paid inheritance tax on their estates and have pensions which would have previously been excluded. Their tax bill is likely to increase by around £34,000 based on previous data according to the report.

If you have the more than £1m then your kids are going to inherit a shit load of money regardless.

Pensions were not designed as inheritance tax savings products. Until 2016 the tax on death on non spouse beneficiaries was 55%!

There are ways to plan IHT if you have assets worth more than £1m. Just need good advice

I stand corrected, @Notsuchafattynow , nil rate for a £500k estate. So if that person dies with anything above £175k in non property assets that money will be taxed twice (IHT and income tax). This is such a disincentive to save into a pension and look after yourself in old age, beyond the basics of what you’ll need.

But the income tax on withdrawing the pension is the income tax that was not paid on the money put into the pension. So it is the same result as inheriting money in an ISA, just the pension pot looks more but it is isn't.

Eg if £100 of Dads wages would =100 in a pension or (taxed at 20% before putting in) 80 in an ISA.

Child inherits and pays 40%. pension = 60 ISA =48.
Pension pot is paid to child 20% tax remainder = 48. ISA no tax = 48

Pensions were never designed to be IHT avoidance! They are there for retirement. If you’ve money left over in your pot as a bonus, then why shouldn’t it be part of your estate? Don’t forget, nil between spouses and dual allowance for direct descendants so it’s only if your assets are over £1m. I can’t understand people saying they’re not going to save into a pension because IHT. So you’d miss out on tax relief at your marginal rate plus the ability to draw 25% tax free because you’re worried about tax when you’re dead? Your kids will still inherit up to £1m tax free!

Trying to look at the substance - the 'deal' between the state and individual for the privileged tax treatment of pensions concerning contributions and returns within the pot is to encourage people to save for their retirement by using income before tax and for the investment returns to be untaxed as well.

As with AIM investments, farm and business reliefs, they have become vehicles for the very wealthy to park wealth outside the provisions of IHT. The budget has changed provisions to try and maintain the substantive purpose of the vehicles while trying to reduce their use as a vehicle for avoiding IHT. Arguably the changes to agricultural reliefs will cause more trouble and difficulties for 'working' family farms though there has been a significant problem with billi9onaires buyug huge farms for IHT relief.

The changes to pensions wouldn't appear to change anyone's ability to save for their retirement then use the saved funds plus investment returns, just reduce the ability for people to use their DC pension as a vehicle to avoid IHT.

The alternative would sound a little fruity - the 'deal' between the state and individual for the privileged tax treatment of pensions concerning contributions and returns within the pot is to encourage people to save for their retirement and to be able to pass money to their beneficiaries outside IHT. Why would the state want to encourage that at a time when the UK has a large public debt and is running a significant deficit and public services have had significant under-investment for many years?

@MrsJoanDanvers spot on.

I know it makes for an inflammatory % but is it a given that if the beneficiary taking an income would pay 40% or could it be 0% through the other income tax rates up to the highest band, depending on their other income?