Currently, pensions are one of the few assets that escape IHT when you die, but that could soon change.
Last month, the Institute for Fiscal Studies called for our unused pensions to be included in estates on death and slapped with the punitive 40 percent inheritance tax charge.
Its report Death and taxes and pensions says the tax system treats pensions “extremely favourably” and this has to change.
It means that instead of spending pension in retirement, retirees first use up other savings such as Isas, which may be free of income tax and capital gains tax, but incur IHT on death.
That way they hope to pass pension onto loved ones.
The proposal to charge IHT on pensions may seem logical but it will be hugely costly, AJ Bell’s head of retirement policy Tom Selby warns. “A pension untaxed on death today could incur more than £500,000 in tax under the proposals.”
Pensions were previously subject to a “pernicious” 55 percent tax on death, until former Chancellor George Osborne removed it in 2014.
That was even more brutal than today’s 40 percent IHT charge on other assets such as property, valuables and savings.
If the pensions death tax was restored at its old level it would trigger outrage, but there is a precedent.
HMRC already taxes pensions at 55 percent, under the insanely complicated and highly punitive pensions lifetime allowance.
So it would be easy to see it introduce a pensions death tax at the same rate.
Selby says it could well happen, and sooner than we think. “Given how tight finances are at the Treasury, it would be no surprise if this came under the microscope ahead of next year’s Budget.
“These new proposals from the IFS are not quite as pernicious as Osborne’s controversial 55 percent death tax on pensions, but they do come close to introducing a comparable penalty on death.”
Selby said the government might be tempted to turn back time to rake in a little more cash, but points out that many people have based key financial planning decisions on the notion that their pension will be free of IHT on death.
Changing the goalposts would cost people tens of thousands of pounds in tax, Selby says: “Those facing a colossal tax bill as a result of a retrospective tax change would understandably feel extremely hard done by.”
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They certainly would, and rightly so. Especially if the tax charge is higher than the 40 percent IHT charge on other assets.
Many will have based their family financial plans around Osborne’s decision, and face huge bills if it is reversed.
Pension planning is already complicated enough.
Another pensions raid will make people even more reluctant to save for the future than they already are.
So will the government do it? Selby says it would create a “significant backlash from savers and pensioners ahead of the general election”, but that didn’t stop Chancellor Jeremy Hunt from freezing income tax and national insurance bounds, as well as the CGT, IHT and lifetime allowance thresholds.
These days no tax hike can be ruled out, however unfair, popular or damaging.
This leaves people in financial planning limbo, with no idea how to save for retirement.
It’s yet another pensions mess and the uncertainty will drag on until we get an answer either way.