Inheritance tax implications - difference between DB and DC pension schemes

[Pandersmum]

Can someone please explain to me (simply) the impact of yesterdays budget on the tax implications on the inheritance of pensions and the difference between ‘defined contribution’ pensions where your build your own pot to provide a pension and a ‘defined benefit’ where you don’t own a pot, but get a guaranteed pension value.

Does the change make defined benefit pensions even more valuable to the the recipient than before?

Also want to know this!

Defined benefit pensions are unaffected because they only ever pass on once to a surviving spouse (or maybe a child, but I guess that is rare). When that spouse dies so does the pension.

If you have a defined benefit pension there's no "pot" to be taxed. The pension dies with you (or in some cases your surviving spouse) so there's no pension to tax.

Essentially with a defined benefit pension you are getting an income each year, there is no capital pot that you draw down from so when you die, no one else receives a capital sum. In some cases e.g. your spouse may get part of the pension income after your death.

With defined contribution pensions, when you retire you can either take an annuity where you receive an income for the rest of your life and that operates in the same way as above. However, you can also just draw down the capital regularly. That means there may be some capital left on your death.

The budget means that in the last situation that capital will now be subject to inheritance tax.

The budget means that in the last situation that capital will now be subject to inheritance tax

But only if the entire estate exceeds the IHT threshold and only if it is being passed to someone other than a spouse. That last part is important as I have seen people panicking on here about that already.

In the past some people with DB pensions transferred them to personal DC pensions precisely to create a larger inheritance for their kids. It's very difficult to do now because so many restrictions are in place to prevent fraud.

I haven't seen any budget news summary that mentions this?

I have a DC pension. IIUC there wouldn't be anything to inherit if I retire and use the pension pot to buy an annuity until death. However if I die before I retire or if I don't buy an annuity but draw an income from the capital pot then my children can inherit the pot when I die.

If the inheritance tax status of such a transfer has changed it's not going to affect very many people. DB schemes are usually better anyway.

Thank you for your replies.

I think this is yet another huge benefit then to those with DB schemes which as someone has said, were already more generous than DC schemes.

Personally I have been saving hard into a DC pension scheme, topping up my 6% employer contribution. Despite saving an additional 20% of my salary monthly, I will be unlikely to buy an annuity which would be comparable to a DB pension on a similar salary to I am now.

Tax payer funded public sector DB pensions are already incredibly generous and I fear that this latest change is a further step to create a two tier pension society going forward - those with a public sector pension will enjoy a certain standard of living and others, a lesser one.

I’m not sure this makes DB pensions any more valuable - as others have pointed out there is not usually a pot so there isn’t usually anything left to inherit.

It is still possible to arrange for a pension pot, on death, to be paid into a trust (and to name the trust as the preferred beneficiary). This may well avoid the pension being considered as part of the estate. People with these in place already might be considering advice to ensure they would survive the new rules.

The thing that most people miss too is that if the pension is subject to IHT it is the liability of the pension beneficiary. And when they draw that down to pay the IHT if they have to then they also pay income tax on the draw down so its a double whammy!!

Most of us DB pension people won't make it to 68 the way they're working us on hospital wards. There's no staff.

That makes absolutely no sense. I really can't see how this change would make any difference to the attractiveness of DB pensions as if your aim is to build a pot that can be inherited by your descendants a DB pension would already be a terrible way to go. There is no pot as such so if you die early it's tough shit, your contributions go towards subsidising those who live longer.

But if you are so convinced rewards packages are so much better in the public sector, why not go and get a job there. There's a massive recruitment and retention crisis so sure you won't struggle!

Inheritance Tax on pensions consultation

If you are properly interested read this link.

It may impact DB pensions. Some schemes have a lump sum death benefit, so this will form part of the estate.

I can't see how it will make "defined benefit pensions even more valuable to the the recipient than before"

Given that currently only 4% of estates pay IHT (BBC link), then the number of estates with pension money that will be subject to IHT will be smaller than this. Government estimates are that less than 1.5% of estates will be impacted.

The IHT will be paid directly form the pension scheme by the scheme provider. So the beneficiary doesn't draw it down.

Exactly!

hypothetically, as a beneficiary I would rather inherit an amount and pay inheritance tax than inherit bugger all.

As a DB pension owner I am very happy to have an income for life when I retire but I full accept I could drop dead a year after claiming (or even before) and there would be nothing to pass on, despite contributing significantly for four decades.

Thank you @PandoraSox and @Diaryfear

I am in the USS which is part DB and part DC. However, I have a while to go before retirement!

I am not building a pot to be inherited by descendants.
I am building a pot to give myself a comfortable retirement.

Unfortunately the benefits of a DC scheme are not as generous as a DB scheme and as a result I was trying to build a bigger DC pot, to try and have a comfortable retirement.
When people try and justify that DB are not that great because you don’t have a ‘pot’ at the end of it, they forget that you have no choice to build a pot in DC schemes.

I have been making tax efficient additional contributions to my pension, but I will now how to revisit that approach.

People work hard and have tough jobs in the private sector too.

How does any of this relate to IHT treatment of pensions or changes thereof?

I am in USS too and my pension can be inherited by children if I die before 68. I guess this is only the DC part and not the DB part?

no it’s the complete opposite of what you’re saying

dc are far better than db for inheritance in terms of passing down to the next generation

all the changes have done is make the benefits less if the dc pot is over the threshold

in terms of the benefits to you as the pension holder the changes make absolutely no difference at all

why would this change your contributions to your dc pension?

Apologies I am no expert here which is why I asked the question …..

Because, if I was to die early and pre retirement age, that pot which would have been passed onto my descendants will now be taxed at 40%, where previously it would not have been taxed. To me that is a big change that I am trying to understand the implications of.

We are being encouraged to save for retirement, especially if we do not have fabulous DB workplace pensions and previously tax incentives were given to encourage long term saving.

I think this change yesterday just made the DC pension saving option significantly less attractive.

You've said it yourself. The purpose of the tax benefits in pensions is to support you to save for your retirement, not to enable you to pass savings to DC tax free.

Ok, I see, I was confused because you were making comparisons to DB schemes (which didn't seem relevant to the IHT treatment of DC schemes).

Saving in your pension is still the most tax efficient way to fund your retirement and although your pension won't pass to your DC tax free if you exceed the threshold, money outside of your pension won't either so you are not worse off from an IHT perspective putting money in your pension.