Inheritance Tax on pension pots

dunstonh

The Daily Mail today have recirculated the hint that inheritance tax could be applied to pension pots where spouse inherited if you died prior to age 75.
They say the government could after a few years be taking £2 billion a year in tax on this.

Its worth noting that Labour have already identified that having pensions subject to IHT would not be fair as it would lead to double taxation on post 75 deaths.   And that for post-age 75 pots, the amount collected in tax under the current rules, if taken as a lump sum, is often greater than the amount collected under IHT (no nil rate band other than personal allowance, additional rate and loss of personal allowance are greater than IHT).  The focus is on the pre-75 tax-free element.  Not whether they can find a way to bring pensions into the estate and tax your beneficiary income tax AND the estate inheritance tax.

Taking away the age 75 rule and leaving all pensions drawn subject to income tax would achieve the same goal and would be a lot easier to implement than finding a way to bring all the different types of pensions into the estate.

This opens a few questions:
If I have a pension pot when I die prior to 75 (very likely to die before I’m 65 due to myeloma) I’d say £275,000. 
On death my wife will inherit my half of house outside of inheritance tax and any monies I have.
Would she then get an inheritance tax relief on the first £325,000 of my pension pot if it’s now taxable?
in this case pay no tax on it?

Seeing as inheritance tax is unlikely to be applied to pensions, it seems pointless speculating what IHT would be if it was.     It will possibly either be income tax without the pre age 75 rule or a brand new tax.... but even that is speculation.

squirrelpie

Tax_Slave said:

I die at age of 65 and my estate is left to my wife aka House (my half) and all my savings £370k.
My wife if inheriting surely doesn’t pay IHT aka she is exempt?

If I had left my pension pot intact then she would pay 40% on inheriting it and zero IHT on my savings and half of house.

Surely she wouldn't pay 40% (IHT?) since as you say she is exempt?

A house is different. If you're joint tenants (the default) then she automatically owns it all if you die - it's not that she inherits your share. If you've chosen to be tenants in common then it is part of your estate and who inherits it is decided by your will. It might be your wife or it might not.

But it's all speculation anyway. Angels on the heads of pins stuff.

af1963

Never really understood the logic of a system that can cause a large tax bill for the inheritor of a pension if the original owner survives a single extra day to reach their 75th birthday, which would not have been due if they had died the day before.

Creates some very dubious incentives for seriously ill people aged 74.

leosayer

How did the age 75 rules come about in the first place?

artyboy

dunstonh said:

The Daily Mail today have recirculated the hint that inheritance tax could be applied to pension pots where spouse inherited if you died prior to age 75.
They say the government could after a few years be taking £2 billion a year in tax on this.

Its worth noting that Labour have already identified that having pensions subject to IHT would not be fair as it would lead to double taxation on post 75 deaths.   And that for post-age 75 pots, the amount collected in tax under the current rules, if taken as a lump sum, is often greater than the amount collected under IHT (no nil rate band other than personal allowance, additional rate and loss of personal allowance are greater than IHT).  The focus is on the pre-75 tax-free element.  Not whether they can find a way to bring pensions into the estate and tax your beneficiary income tax AND the estate inheritance tax.

Taking away the age 75 rule and leaving all pensions drawn subject to income tax would achieve the same goal and would be a lot easier to implement than finding a way to bring all the different types of pensions into the estate.

This opens a few questions:
If I have a pension pot when I die prior to 75 (very likely to die before I’m 65 due to myeloma) I’d say £275,000. 
On death my wife will inherit my half of house outside of inheritance tax and any monies I have.
Would she then get an inheritance tax relief on the first £325,000 of my pension pot if it’s now taxable?
in this case pay no tax on it?

Seeing as inheritance tax is unlikely to be applied to pensions, it seems pointless speculating what IHT would be if it was.     It will possibly either be income tax without the pre age 75 rule or a brand new tax.... but even that is speculation.

Another obvious challenge is that if pensions were somehow brought within an estate, the whole concept of expression of wishes would have to change - because there would be no value to maintaining the current discretionary trust structure. And the next knock on effect would be that a lot of people would need to consider rewriting their wills to account for an asset that can't currently be included.

Frankly it would be very/too messy, or at least that's what I'm hoping as my estate would likely get clobbered. Admittedly I'll be dead, but it wasn't what I'd planned for my kids. Ah well. 🎻

squirrelpie

There's already the probate interaction with IHT problem to be solved (i.e. you need probate to manage the estate to e.g. sell a house, but you have to pay IHT before you can get probate, and probate can take a really long time to be granted). Adding pensions into probate as well would make things much worse. So I don't think there are any quick changes likely in that direction.

Marcon

leosayer said:

How did the age 75 rules come about in the first place?

Not sure there's any real explanation. Possibly linked to the fact that tax relief on personal contributions stops at 75.

dunstonh

leosayer said:

How did the age 75 rules come about in the first place?

Personal Pensions could only be held until age 75 when introduced in 1988.   You had to annuitise them before age 75.  

Life expectancy was lower in 1988.     Just as terminally ill people can access their pension tax free, it was seen that allowing those that die before their pension is commenced should see their beneficiary (typically spouse) receive the fund tax free.  Especially as so much retirement provision is weighted towards the one spouse. Often the other spouse has little or nothing.

The pension freedom legislation kept the age 75 in place for death benefits but removed the annuity compulsion.

Qyburn

af1963 said:

Never really understood the logic of a system that can cause a large tax bill for the inheritor of a pension if the original owner survives a single extra day to reach their 75th birthday, which would not have been due if they had died the day before.

Is that how it works, the beneficiary gets taxed immediately they inherit a DC pension? Without ever having looked into it first hand, I had assumed (rashly?) that the beneficiary would only pay tax as they drew from the pension.

Marcon

Qyburn said:

af1963 said:

Never really understood the logic of a system that can cause a large tax bill for the inheritor of a pension if the original owner survives a single extra day to reach their 75th birthday, which would not have been due if they had died the day before.

Is that how it works, the beneficiary gets taxed immediately they inherit a DC pension? Without ever having looked into it first hand, I had assumed (rashly?) that the beneficiary would only pay tax as they drew from the pension.

Where tax applies, the beneficiary gets taxed on withdrawals, not at the point of inheritance.