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It is undoubtedly one of the notable attacks of the Budget. Pension savers have been dealt a surprise blow as they now face a new inheritance tax.
Families will suddenly have to review their inheritance plans because starting April 6, 2027, they will have to pay inheritance tax at a rate of 40 percent.
But what does this mean? Here we look at how much the new tax raid could cost you and what you can do to protect your pensions.
In one of the most high-profile attacks on the Budget, Rachel Reeves has dealt a surprise blow to pension savers, who now face a new death tax.
What exactly is changing?
Until now, private and workplace pension funds were not part of your estate in the event of death and were therefore not subject to inheritance tax.
This meant that any money remaining in your pension upon death could be transferred free of inheritance duties, making them a tax.
efficient way to leave money to the next generation.
However, Ms Reeves announced yesterday that from 2027 pensions would no longer be exempt.
Any unused pension savings will add to the value of your estate and could result in a tax bill.
People can pass on up to £325,000 after their death free of inheritance tax, known as the nil rate band. Couples who are married or in a civil partnership can combine their allowances to get £650,000.
Anything over this amount is taxed at a rate of 40pc. There is an additional allowance for transferring homes (see overleaf).
John Chew, tax and estate planning specialist at pensions group Canada Life, says this will ensure inheritance tax is no longer paid only by the rich. Middle-income families will also be caught in the net.
It says: ‘This year, around 5 per cent of households will be subject to inheritance tax. As a result of the changes announced in today’s Budget, this figure is expected to almost double between now and 2030.
‘For example, before the Budget, the beneficiaries of someone with assets worth £300,000 and a pension fund of £107,300 (the average pension fund for a person aged 55 to 64, according to the Office for National Statistics), they would not have been subject to payment of inheritance tax.
“Now, however, they will find themselves with a bill of just under £33,000.”
What pensions will be affected?
The new death tax will largely apply to those in the private sector who have saved in modern defined contribution pensions.
Most workers today save in these pensions and accumulate a fund of money that they can use during retirement.
It is important to remember that this does not apply to spouses or common-law partners, who are exempt from inheritance tax.
Currently, any remaining funds left after death can be transferred to your loved ones free of inheritance tax. But this will change in April 2027.
The reform will not apply to public sector defined benefit pensions, which guarantee workers an income in retirement. These pensions usually die with the saver.
However, some public sector workers who have chosen to withdraw cash from their defined benefit pension in a lump sum and put it into a defined contribution pension will be caught in the tax net.
Will my spouse pay IHT on my pension?
No. All assets left to a spouse or common-law partner are exempt from inheritance tax.
Is my pension insured?
When major pension reforms were made in the past, previous governments are known to have put in place protections for savers to safeguard money already accumulated in a pension.
The Chancellor did not indicate in her Budget yesterday that there would be such protections, but the fact that the change will not come into force until 2027 suggests the details still need to be worked out, says Tom Selby, director of public policy at stockbroker AJ Bell. . .
It says: “As is often the case with pensions, the implementation of any new death tax will pose substantial challenges, which is why the changes will not be introduced until 2027.
‘A major hurdle centers on how to treat people who have made decisions about their retirement fund based on the pension tax rules as they exist today.
‘There will be, for example, people who choose to transfer defined benefit pensions to a defined contribution scheme partly because they wanted to prioritize the efficient transfer of tax money to their loved ones.
‘Anyone who has made larger contributions to their defined contribution pension to make the most of the existing rules will now also wonder what might happen to their fund when they die.
“If suddenly that money was subject to a new pension tax, those people would understandably feel like the rug had been pulled out from under them.”
What can I do to solve it?
The Government’s official pension agency hopes that many families will act preventively to protect their pension savings from this new tax appropriation.
There are several tricks it hopes pension savers will use to protect £2.2bn from the taxman in the first three years after its introduction.
This includes withdrawing larger amounts from pensions to channel the money into accounts and assets that are exempt from inheritance tax.
Savers can still withdraw 25 per cent of their pension wealth tax-free and this money can then be invested elsewhere or donated during their lifetime.
You can make an unlimited number of cash gifts, as long as you survive at least seven years after making them, as they will then be out of your estate.
Baroness Ros Altmann, former pensions minister, says: “Pensioners will be encouraged to spend their pension while they are still relatively young, leaving much less to live on if they survive to an old age.”
“Most people underestimate their life expectancy, so they are likely to have spent their pension long before they reach old age, so they will potentially have less to live on than they would otherwise have and less money to live on.” spend on the care of the elderly.
Savers can still withdraw 25 per cent of their pension wealth tax-free and this money can then be invested elsewhere or donated during their lifetime.
Is it worth saving for a pension?
Pensions remain a tax-efficient way to save for the future.
Any money saved in a pension fund still attracts tax relief at the worker’s marginal income tax rate and 25 per cent of the final pension fund can still be withdrawn tax-free. Workers who save for a pension also receive employer contributions in addition to their savings.
However, Myron Jobson, of stockbroker Interactive Investor, says the appeal of pensions may be “somewhat blunted” by the new inheritance tax.
Savers may need to weigh saving for a pension against other tax-efficient accounts, such as Isas, which offer more flexibility for those who need to access money early.
Anything else to keep in mind?
Mark Levitt, a partner at tax firm Blick Rothenberg, warns that those who inherit a pension may now face a double tax hit on that money.
This is because loved ones must pay income tax at their marginal rate on any money they withdraw from an inherited pension.
Currently, if you inherit a private pension from someone who died aged 75 or over, you will have to pay income tax.
If they are under 75 years old, there is no tax charge. But starting in 2027, both income tax and inheritance tax can be collected.
A higher rate taxpayer who inherits a pension worth £80,000 as part of an estate that exceeds the nil rate band would face an inheritance tax bill of £20,181.82 on the pension, Levitt says.
However, they would also face a 40 per cent tax bill on any money they withdraw from the pension, meaning they would have to withdraw £33,636.37 to pay the inheritance tax bill.
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