Will a ‘death tax’ be imposed on pension savers in the Budget and what would it mean for you?

Pensions are not currently included in assets that count towards inheritance tax, but that could change in any major budget reform.

The taxman treats retirement savings generously when people die these days, especially if it happens before age 75.

They have therefore been widely used in inheritance tax planning and are often spent last, if at all.

Pensions were not intended for this purpose but to fund retirement, and could largely be spent again over people’s lifetimes if rules were tightened in the 30 October Budget.

Options open to the Government include making pension assets subject to inheritance tax and charging them a charge on death.

Pension and tax experts predict that a crackdown would lead to increased giving and perhaps greater use of trusts and insurance products.

We look at the rules on transferring pensions to your loved ones now and how they might change.

How are inherited pensions currently taxed?

Beneficiaries of most defined contribution pension funds do not pay taxes if the owner dies before age 75 – but there are some complicated rules to keep in mind, especially in larger funds.

The deceased pension holder has a “lump sum and death benefit” limit of £1,073,100 which they can enjoy tax-free.

This limit includes prior tax-free lump sums and critical illness lump sums received while still alive.

But there is an exemption if a lump sum is paid before April 6, 2024 with funds previously matched against the now abolished lifetime allowance, explains Quilter’s head of retirement policy, Jon Greer. This is to ensure that the same pension is not tax tested twice.

There is also a very important time limit that you must meet.

Lump sums and beneficiary pensions are only tax-free if the lump sum is paid or the beneficiary’s pension is established within two years of notifying the pension plan of the death, Greer notes.

“As long as the beneficiary’s retirement arrangement or annuity is established within two years of the plan’s death notification, the proceeds will be tax-free.

‘There is no limit to the size of funds that can provide this tax-free income, as the lump sum and death allowance only test lump sums.

‘But unlike lump sums, there is no limit on the size of funds that can be rolled over as an annuity or beneficiary withdrawal and provide tax-free income, as the lump sum and death benefit allocation only prove lump sums. global.

“It is incredibly generous and may be something the Government is considering in the next Budget.”

On any sum that falls outside the scope of the rules explained above, the beneficiary pays his normal marginal income tax rate: 20 percent, 40 percent or 45 percent.

Beneficiaries of defined contribution pension funds must also pay their normal income tax rate if the holder Dies at age 75 or older.

You need to be careful in this scenario, because you can easily be pushed into a higher tax bracket when withdrawals from an inherited pension are added to your regular income.

This could happen even if you try to spread the sums over several years to minimize your tax bill.

Meanwhile, payments from an inherited pension to a non-individual, such as an estate or trust, are subject to a 45 percent tax charge, Greer notes.

“If the lump sum is paid into a discretionary trust, the beneficial owner will receive a tax credit for the 45 per cent tax charge.”

In the case of annuities, the principal is generally lost after you and your spouse die.

But Greer points out: ‘Annuities can provide a guarantee period in which income will continue to be paid for a set period even if you die.

‘There are some annuities available that provide principal protection, but they are very few and the annuity rates they offer are typically lower. The tax treatment is the same as described above.’

Meanwhile, final salary pensions also usually end upon the death of the holder or his or her surviving spouse.

Some pay benefits to others, such as children, in cases where they ultimately remain dependents, if permitted by plan rules.

What do money experts say? People will be more likely to spend pensions throughout their lives

“The inheritance tax treatment of defined contribution pensions is currently very generous,” says Charlotte Ransom, chief executive of Netwealth.

‘Currently, pensions are left out of the estate in the event of death from an inheritance tax point of view.

“In addition, those who die before age 75 will be able to transfer the full value of their pension free of income tax.”

Pensions and tax experts: from left, Jordan Gillies, Charlotte Ransom and Helen Morrissey

Ransom says the Government could decide in the Budget to limit pension assets that can be left out of an estate on death, or only allow them to pass tax-free to a spouse as with other investments.

According to Ransom, people are more likely to spend pensions over their lifetime if they change their tax treatment.

He adds that his company is already seeing people opting to receive 25 per cent tax-free lump sums before the budget.

Ransom notes: “Any reduction in the tax-free cash currently available for pensions would essentially mean paying more tax on pension income, resulting in a smaller retirement fund than would otherwise be the case.” .

Inheritance tax or a pension charge may be levied upon death

Helen Morrissey, head of superannuation research at Hargreaves Lansdown, says: “Currently, pensions tend to sit outside people’s assets for inheritance tax purposes, a move that sets them apart from other products such as Isas.”

‘Given that income tax is also not payable if death occurs before age 75, it means that people have tried to spend down their other assets and leave their pension to pass on to their loved ones.

“One change could see loved ones of a single, childless person with a house valued at £300,000 and a pension of £200,000 receive a bill of £70,000 when, under current rules, there would be no inheritance to pay”.

As to how this might work in practice, he says an inheritance tax could be levied on deaths after age 75, or a separate charge on pension assets, as was the case in the past before the pension freedom reforms in 2015.

“A separate charge would be an easier option to implement,” Morrissey says.

“Any such change would certainly have a big effect on people’s behaviour, who would look to reduce their pension in retirement, either by making gifts to loved ones or by increasing spending.”

Many rich people dipped into their pension funds for the last time

Jordan Gillies, tax expert at wealth manager Saltus, says: “Currently, pensions can be passed free of inheritance tax, but after age 75 they are only accessible at the beneficiary’s marginal tax rate – potentially 40 or 45. percent”.

“Therefore, removing inheritance tax benefits from pensions could create a double tax impact for beneficiaries.

‘Many high net worth people turn to their pension funds last to make the most of the hereditary benefits currently accruing to pensions, but this change could alter that approach.

‘The recent trend of increasing pension contributions following the removal of the lifetime allowance could be reversed, pushing many towards options such as nil rate band trusts.

‘Although if the zero rate band is removed (which would appear to be a stealth tax), families may be forced to explore other options, such as insurance products for estate planning.

“It would also likely increase donation levels, which could reduce Treasury revenue.”