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

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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.

They spotted a tax avoidance scheme for the rich, which is great

We were hoping to pass some of our pensions on to our children when we die. However, I think this is a fair cop! I have not read all of the links, but had you not put money into the pension you would have been taxed on it so maybe it is right that you pay inheritance tax on a taxed pension.
Our income is made up of state pensions, DC pensions that we can take when we want and stocks and shares ISAs that we have changed from investment to income. We have saved in the ISAs for a long time. I have really appreciated the ISAs as because as they are tax free we are only basic rate tax payers therefore if we pay any CGT on other things it will be at the lower rate.
Yes like other people on this thread we are spending more which goes against our nature. We are also giving some to our children. If only we knew when we would die! At least the time limit wasn’t changed to 10 years.
A poster on here suggested that she would be paying for her children’s holidays because if you pay an amount to a holiday company they don’t know that the holiday is not for you.
Now off the read the links!

Which?

@Brananan FOY i used to work for HMRC many moons ago. All peeps earning over a certain amount, will have accountants advice to divert a level of income into inheritable pension funds. As such this diversion attracted retirement annuity relief.

And avoided IHT. Perfectly legal.

My case load was higher earners, and the annual diversions were massive. We are talking early 1990’s and million plus per annum.

My mum did this too on sound tax avoidance advice.

The beneficiaries will only pay income tax on the drawings from the pension if they are over the threshold in that year. They could leave it until they retire, then take out only just enough to top up their income to the tax free threshold.

Either live like a poor person, or take the income and pay the tax.

So what's the problem?

@Brananan They have stopped it so there is now no problem. Job done

I suppose the question of fairness is this: an individual may have worked 10 hour days to accumulate said wealth, taken promotions with increasing responsibility and stress thinking their descendants will benefit and won't have to work as hard. If 67% is taken by the government and used for public services - great for the government, great for the public, but not so great for the person that made the extra sacrifice. Many people choose to coast a little, spend more time with family, work less etx and earn less and thus accumulate less. That is also perfectly fine. What is the incentive for the individual that goes the extra mile?

Do we want to discourage that? How does that affect society longterm? I guess such people have less and we all have less to share

Not all wealth is stroke of luck, right place at the right time - I can see the virtue in taxing that at 67%. Others are accumulated by specific planned strategy and some policy actions discourage such individuals.

I still think there are ways around it anyway - give now, spend now, invest in your offspring and grandchildren now. Pay their private fees etx. Whilst we increase minimum wage, we need to incentivise those who are willing to innovate, take risk, go the extra mile

If the majority of an estate is a house bought 30 or 40 years ago it’s money nobody’s worked their arse off for and it’s never been taxed. A share of a tax free £1 million windfall should surely be enough for anyone.

They have worked hard to pay the mortgage off most likely. Could have paid rent and spent the rest on holidays and living life. May have opted to go for that promotion to earn enough to buy their own home which they pay for over 25-30 years including interest to their bank and enable others to avail themselves of state-subsidised housing - thereby saving the taxpayer money

The proportion of people who buy a house outright without a mortgage- infact less than 5% according to the stats.

So this idea that house wealth is some sort of pot-luck needs checking.

It is good to support public services by contributing a portion of earning via tax - including accumulated wealth. But this idea that wealth generated is just luck needs to be quenched. Why would the next generation work hard or aspire - if they are told it is not in their hands to some extent?

We should be striving to ensure we 'create luck' for the next generation

I understand on Moneysaving website and Telegraph Money that if your pension pot is left to spouse it’s free of tax even after 2027 when the change kicks in.

Couldn’t you just do a Deed of Variation of your late spouses will to leave to your grown up children if you didn’t need it yourself?

Rather idealistic. People will just give lump sums to their children while still alive instead of leaving it in their will. I guess you think that is unfair too.

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?

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.

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

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.

@Leavesontheroad How does this policy encourage downsizing? I would say it doesn't really affect that decision one way or the other really. The best way to encourage downsizing would be to set stamp duty to zero and introduce a land value tax, but obviously that isn't going to happen.

If anything, inheritance tax on pensions will slightly discourage downsizing by encouraging people to fully use up every penny in their pension (whose value would otherwise be subject to tax of up to 67% when inherited) before selling their big house (whose value would only be subject to tax of up to 40% when inherited, and additionally comes with a big uprating of the nil rate band).

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

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?

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.

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.

@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.

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.

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

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