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?

Up until the budget if you had a defined contribution pension if you died before 75 years old you could nominate who received your pot tax free. Now it will be taxed. Defined benefit should not change.

DB schemes can’t be passed on in the same way as DC schemes and so most are unaffected. Eg most don’t even allow the surviving spouse to inherit unless they’re over a certain age.

This government is determined to stop parents passing on most of what they have worked for themselves to their own DC yet very happy to accept tax free handouts themselves for glasses, clothing, football hospitality, stays on pent houses and Taylor Swift freebies.

You are very naive if you believe people don't own houses worth more than £360k or £500k, even without their other wealth.

DB schemes have massive problems though, you can't vary how much you put in and the scheme calculates your theoretical contribution, then taxes you on it. this relates to inflation - one year, my husband theoretically put into his pension scheme all but £5k of his income, and so got heavily taxed as he had exceeded annual allowance - but of course he hadn't actually contributed anything like that amount. NHS scheme is a shadow of its former self in terms of benefits.

Lot of resentment in your posts. Go and work for the public sector if you think the pension is so much better. Lots of teaching jobs need filling

I’d prefer a DC scheme to a DB scheme to
be honest - I’ve got both.

a lot more flexibility with DC and taking into account investment gains over medium to longer term theres unlikely to be a huge difference in drawing down on a DC scheme than DB promised amount.

yes with a DC scheme there is a risk of a market armeggedon but even with that when investing for the long term risks can be minimised

and - as said - the dc pot being inheritable is itself a massive advantage over db schemes

And I’m not sure you still don’t get that the “penalty”
won’t be felT by those with db pensions because they don’t have the benefit in the first place

as someone said - the pension benefits invariably reflect a lower salary

id much rather have a higher salary and save all the difference into a dc pot

They have a death benefit to their beneficiaries if they die before they reach pension age or very shortly after (most schemes). This death benefit lump sum will now form part of the estate.

Is that from the pension, though, or more of a life insurance payout? If the latter, it might be treated differently.

There is no insurance as such, it is effectively some of the pension that the deceased never got to claim so will not be treated like insurance.

Ah, thanks.

I can understand people feeling envious of anyone with a DB pension, but please bear in mind that anyone in the public sector has more than likely had a lower income throughout their career than someone in an equivalent job in the private sector. A better pension may be the reason they settled for that. I'm not denying that it's great to be in a final salary or average salary scheme, but if you're looking at this from the outside the final salary probably isn't as much as you think.

I think this may be mixing two things. Employers including public sector often offer a death in service benefit - eg 4x salary to your dependents if you die whilst working. No proposals to tax that I’m aware of.
DB schemes may also a ‘minimum pension guarantee’ whereby they’d pay a set amount to your dependents if you die eg 2 months after retiring. Not aware this comes in scope either.
Then a spousal pension if payed is taxed as income rather than as a lump sum.

I guess if you wanted to avoid potential IHT on a DC pension you could buy a joint life annuity if planning to leave to your spouse - but I assume the current rules of being able to leave your whole estate tax free to your spouse would continue to apply and include your pension - so it would only be taxed via passing down to kids etc. But this isn’t clear from the planned legislation yet

Not resentment. Just an observation.

I’m a senior manager working for a family business employing 40 people in the private sector. We do make a small profit, but it’s not comfortable or guaranteed. Our team are hard working people (as are many people in the public sector).
I wish we could pay them more and provide better pensions, but the reality is we cannot.

Even before the budget, lots of comments from my wider team about how our pension scheme is not a patch on their public sector working spouses (teaching, NHS) or that of their parents.

Many of my team are still supported in their 30’s and 40’s with e.g.holidays and housing support, by parents who had final salary scheme private sector scheme pensions (retired in the 80’s which no longer exist in most cases) and NHS pensions. My team are fortunate to have that support but it is not sustainable to the next generation.

As I said in an earlier post, I genuinely fear that going forward there will be a significant ‘pension divide’ …. and it’s just not possible for everyone to work for the public sector …. some people need to work in the private sector to pay the business taxes to fund the public sector!

They can still pass on at least 60% to their children if they want to

Actually you are not passing on 60% of a private pension to your children. The real scandal us that double taxation will apply.

Your children will be taxed 40% inheritance tax and then they will be taxed again when they take any money from the pension, resulting in 67% taxation.

Martin Lewis mentioned this on his budget show.

But after they have inherited up to the nil rate band, which depending on parental circumstances, might be as much as £1m before any tax. It’s not a scandal.

And back when everyone bought annuities, there was no pot to pass on because annuities die with the person (or possibly pay some death benefits to the spouse and then cease).

Yes but double taxation doesn't operate on any other part of inheritance. If you have a £1.5m house , then your children pay 40% tax on the additional 500k. I have no issue with that.

However for an inherited pension plan, they will pay inheritance tax and income tax, resulting in 67% tax.

Double taxation is considered unjust. Even Martin Lewis expressed shock about this on his programme.

Double taxation may be unjust but people are inheriting a pension pot. It's not a savings account that mum or dad paid into. In many cases the employer pays more than the employee. It is a benefit intended to be used whilst the person is alive to fund them into retirement.
If mum and dad were able to not use it and use other means to survive then that means they were quite wealthy really. So probably the family needs to look at all the money they've got. Maybe all it is they now use pensions first rather than last as that tax loophole is closed.
It also may get changed in a future budget.

The person drawing a pension pot as income does pay tax on it, though. The chances are, for the most part, this will be the person who saved the money. This money had tax breaks on the way in.

If I inherit &200k in savings from my mum, she paid income tax on her earnings before saving this:

I do see what you are saying; I just think that tax has to come from somewhere and inheritance tax is one of the more painless sources vs increasing income tax etc.

Good point @Whyherewego

We pay double tax all the time. Eg the money you use to buy a house - income tax then the same money gets stamp duty sliced off it.

If you are saving for your retirement into a DC pension, the change in IHT should not make any difference to your situation.

If you were saving into a DC pension without anticipating using it in retirement but as a vehicle to pass assets on tax free on death, then you should reassess.

Tbh I'm in finance and the vast majority of people I know are saving into a DC for their own use.

My only note of caution is looking at what your potential IHT bill could be now that DC pensions are included and seeing whether you want to take out any additional insurance policies to cover any shortfall you have in the IHT amount so that your DC don't have to scramble to sell assets to pay the bill (I'm a single parent so all my assets go to my kids and I don't want them in a difficult situation when I die!).

DB pensions have always been much worse from an inheritance perspective and still are. They are generally better while you are alive.

I can understand people grumbling about public sector pensions being better than private sector (although IME public sector salaries are significantly lower, so swings and roundabouts really). I can’t understand someone using the new IHT changes as a basis for this grumble. Public sector pensions don’t attract IHT because they just stop paying out on death (except to a spouse- in which case there’s no IHT anyway)- 60% of something is still better than 0%

Where you have a point, OP, is on the tax treatment of pensions of those dying after 75. It’s clearly wrong for these to attract both IHT and income tax. A better approach would be for pensions like this to come out of the pension wrapper on inheritance, so they are simply treated as cash sums taxed at 40% although obviously this means some people will be paying less as a result of the changes than they would have before (not many though). That’s nothing to do with DC v DB though