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?

Mostly, DC pensions will now be tax neutral, at least if there are no large employer contributions. Is there really still a benefit to locking your funds away for decades?
If you stick the money into property you will not be taxed unless you sell. Assuming 40% tax on death but no income tax on the remaining fund, this seems to be a much better option as it can also generate an income while you hold it.

You don’t get tax relief on contributions into property.

A lot of people will be getting higher rate tax relief on the way in but basic rate on the way out (plus at the moment most people can still take 25% tax-free)

So they are still as tax efficient as they were, assuming you are using them for their intended purpose and not as an IHT dodge!

Not true. Contributions to DC pensions get tax relief, and all gains and dividends inside the pension are tax free. When you withdraw you get 25% tax free, the rest at your marginal rate

Given the tax regime for second properties it is a stretch to say they are a better option than pensions

@messybutfun this is totally incorrect. Tax relief remains on dc contributions

One of the main disadvantages of the Defined Benefit Scheme has always been the inheritance bit. Usually you can only pass it to a spouse and often it's at 50%. I have one from an old job. It's worth £9k a year but I can only pass on half of that to my husband. On the other hand I can pass on my defined contribution pot in full. Although subject now to IHT. I know someone who cashed in their DB scheme and moved to a DC scheme because her DH has no pension so she is protecting him.
So no this doesn't make DB schemes more valuable.

I’ve got both. With my DB scheme, if I die, my husband gets around a third and then that pension ends with both of us- ie nothing to pass on. With my DC scheme I could pass it to my husband inheritance tax free but age would matter re drawing down.

It does mean though that there is not much point leaving loads in a pension for inheritance if the beneficiaries are higher rate tax payers. Eg a pension (over IH threshold) of £500k would be reduced to £300k whixu a higher rate tax payer would need to pay 40% to use so the £500k is then effectively £180k. It would be much better to spend some wealth in old age than try and save it for children or grandchildren.

Now that I am being forced into using my pension, I will pay tax of 40% on all of it - the 75% that is taxable as income to me at 40% and the 25% that I can withdraw tax free which will sit in my estate that will be taxed at 40% inheritance tax. If I die before withdrawing any monies and any monies that I don‘t use, will be taxed 40% inheritance tax and my beneficiaries will be charged income tax on anything that‘s left.

Considering that most of my working life I only received basic rate tax relief, it is not really a tax relief for me.

i can take 60% of my income now and invest that elsewhere. Unless I sell before I die, I will not pay tax on any gains.

This would have been hugely beneficial to me. My last surviving parent died last year. They left everything to me and my sibling and it was well below the inheritance tax threshold. But they were 75 so we have to pay income tax on the pension. Had yesterdays changes already been implemented we would have had no tax to pay.

@Diaryfear Everyone pays pension contributions before tax. Doesn’t matter what type of scheme you are in. The self employed need a far higher rate of saving to be remotely on par because rhe government does not contribute to their pension pot. For state employees it does. For employees like doctors it’s a whopping amount. This is why the self employed have been able to keep their pension pots and leave them to others. They have been the sole contributors. For others where the state pays the pension contributions (used to be no contribution at all from civil service employees) they don’t own the pot in the same way. They do though pay tax when it exceeds the limit set for size of pot. And so they should as it was not all paid from their money in the first place and everyone else has to pay this tax. It’s anti saving though which is poor for the economy and does not aid growth.

You would still have had to pay income tax, that requirement has not been removed. You will now pay income tax after IHT

I didn’t realise that. I guess it would have made no difference to us then as we would still be well below the inheritance tax threshold even if the pension was added as it wasn’t very big.

Interesting responses on both sides of the discussion. I appreciate that.

A former senior tax partner of RSM states in ‘the Times’ letters today that his view is that this change is destabilising to the pension industry and recipients of someone passing away aged 75 or over, now face an overall tax bill of 67% on DC pension pots. He expects there will be legal challenge regarding this proposal.

For someone trying to plan their future finances carefully, including primarily funding my retirement, putting additional saving into a DC pension does not look as attractive an option as it did pre budget. As previous posters have said death is not an exact science and so I should consider alternatives.

I did not intend to ‘bash’ DB pension recipients, and as these are principally public sector employees their guaranteed pension pots are private sector tax payer funded, however I continue to be surprised by those receiving them not understanding just how lucky they are. They may not have a pot to pass on, but they have guaranteed pension benefits, which those in DC schemes do not have.
DC savers are forced to save to significant amounts to try and have similar benefits to DB and now there is a new large penalty that will be applied to DC savers depending upon when they die.

This ‘penalty’ will not be felt by those with DB schemes, so will not be felt by public sector employees.

Martin Lewis gave a good explainer on his show last night. Summarised here:

Autumn Budget 2024: Pensions to be subject to inheritance tax

Only 50% is passed on.

Thank you

It won't be felt by people with DB schemes because they can't pass their pensions on, apart from 50% to a spouse!

Most public sector workers accepted a lower rate of pay than they would receive if they worked in the private sector, the trade off being a good pension.

Private sector workers get perks that public sector workers don't. Swings and roundabouts!

@PandoraSox It’s not swings and roundabouts. The pensions cost the self employed significantly more. When the government contribution is so high for state pensions, that more than balances any salary difference. There’s a gulf between pensions when you look at many businesses that are barely making any money, let alone able to put in 20-30% of profit into a pension! Contributions are capped too and lots are taxed over £1.2 million I think it is. There are no breaks for employing people and growing the economy.

Yes but public sector employees never had the benefit of being able to pass on a pension pot to their dependents in the first place.
Many of us recognise we are lucky to have DB schemes and we do pay into them. The ones who have the massive DB pots are few and far.between, the majority are getting a DB pension on a modest salary.

The pay difference used to be true decades ago, but not now.

There have been many reports which show that that public and private sector pay is around the same and sometimes even more in the public sector.

It doesn't matter anyway. The way this goverment is destroying the private sector means that there will only be public sector jobs soon anyway and then there won't be any public sector pensions at all as there will not be any private sector to tax to pay them because the whole public sector and their pensions will collapse.

It doesn't matter anyway. The way this goverment is destroying the private sector means that there will only be public sector jobs soon anyway and then there won't be any public sector pensions at all as there will not be any private sector to tax to pay them because the whole public sector and their pensions will collapse

I can fairly confidently say that this is very very unlikely to happen, unless there is some massive catastrophe that no-one could forsee.

Why would you rethink that? It makes no difference to the amount you will receive in retirement. If there is money left in your pot after you die, then IF your estate reaches the threshold, your children will still benefit from an unearned windfall, just smaller than it would have been previously. I can’t see why you’d now want to change how you save for retirement.

Why is it unlikely to happen?

All this government is doing is destrying the private sector. Who do you think pays for the public sector?

If there is no private sector then there is no public sector and no public sector pensions.

Public sector employees pay tax and NI at the same rates you do, and also make contributions to our own pensions.

OK @IMustDoMoreExercise . Time will tell!

I might save this post to revisit in 2029 when all will be ashes around us.

Average DB pension is around 5k per annum.

It is predominately made up of low paid worker such as care assistants.

The large pensions talked about are few and far between and often relate to Chief executive positions.