Inheritance tax on pension funds

Sterlingtimes

zagfles said:

Plus DB beneficiary pensions are already subject to income tax. Instead of making DC subject to IHT they could just bring DC drawdown in line with DB beneficiary benefits and make them subject to income tax. 

If the pre-age 75 income tax benefit is withdrawn and/or IHT is applied, could taking out an annuity on crystallised funds be more attractive?   

Linton

zagfles said:

Albermarle said:

Triumph13 said:

[Deleted User] said:

Pat38493 said:

It's been stated here a few times that making pensions part of the estate would be legally very tricky and couldn't be done quickly.

For a DC pension, this would be trivial to do this and would be done as part of a normal Finance Act process.  

How it would be done for DB pensions is trickier.  Not in terms of the legislation but in terms (i) the political process for deciding the value of the pension to include in the estate, and (ii) for the payment of tax without upsetting the funding of some pension scheme (e.g. the assets no longer match the liabilities). 

As DB pensions are normally only inherited by the spouse, or minor children, I can't see any political party wanting to include them - unless they start being set up specifically as tax avoidance schemes somehow.

For DC it would be very simple to just have a flat tax charge at death, unless the funds are going to a spouse.  A 25% charge would mean subsequent basic rate withdrawals by the inheritors would have been charged 40% in total.  If you go higher than that, then a lot of people will just avoid it by withdrawing at 40% and gifting the proceeds, so that they avoid IHT if they live another seven years.

You ( and the previous poster)may well be right about it being simple to change DC pensions tax treatment on death.
However many commentators seem to think it would not be so easy, mainly I think due to having to change trust law.
I am not an expert so do not know the answer, but thought it was worth pointing out there are differing views

IHT is already charged on DC pensions in some circumstances eg contributions made when terminally ill. See IHTM17043 - Pensions: IHT charges: contributions made whilst in ill-health - HMRC internal manual - GOV.UK (www.gov.uk) 

That surely is under very different circumstances.  It is an anti tax avoidance measure to stop people putting money into pensions on their death bed, very similar to the 7 year limit for IHT on gifts except the limit is only 2 years.  IHT is applied on the assumption that the payment into the pension did not occur. So IHT is applied to the contributions, it is not a tax on the pension itself.

This is rather different to applying IHT to the whole of someone's pension which has been built up over many years and perhaps mostly already used up.

Triumph13

Linton said:

zagfles said:

Albermarle said:

Triumph13 said:

[Deleted User] said:

Pat38493 said:

It's been stated here a few times that making pensions part of the estate would be legally very tricky and couldn't be done quickly.

For a DC pension, this would be trivial to do this and would be done as part of a normal Finance Act process.  

How it would be done for DB pensions is trickier.  Not in terms of the legislation but in terms (i) the political process for deciding the value of the pension to include in the estate, and (ii) for the payment of tax without upsetting the funding of some pension scheme (e.g. the assets no longer match the liabilities). 

As DB pensions are normally only inherited by the spouse, or minor children, I can't see any political party wanting to include them - unless they start being set up specifically as tax avoidance schemes somehow.

For DC it would be very simple to just have a flat tax charge at death, unless the funds are going to a spouse.  A 25% charge would mean subsequent basic rate withdrawals by the inheritors would have been charged 40% in total.  If you go higher than that, then a lot of people will just avoid it by withdrawing at 40% and gifting the proceeds, so that they avoid IHT if they live another seven years.

You ( and the previous poster)may well be right about it being simple to change DC pensions tax treatment on death.
However many commentators seem to think it would not be so easy, mainly I think due to having to change trust law.
I am not an expert so do not know the answer, but thought it was worth pointing out there are differing views

IHT is already charged on DC pensions in some circumstances eg contributions made when terminally ill. See IHTM17043 - Pensions: IHT charges: contributions made whilst in ill-health - HMRC internal manual - GOV.UK (www.gov.uk) 

That surely is under very different circumstances.  It is an anti tax avoidance measure to stop people putting money into pensions on their death bed, very similar to the 7 year limit for IHT on gifts except the limit is only 2 years.  IHT is applied on the assumption that the payment into the pension did not occur. So IHT is applied to the contributions, it is not a tax on the pension itself.

This is rather different to applying IHT to the whole of someone's pension which has been built up over many years and perhaps mostly already used up.

Bringing pensions into IHT would indeed be horribly complicated. Until the rules changed in 2014 though, the DC trust simply ended with the death of the pensioner and there was a 55% tax charge on remaining funds before they went to the nominated beneficiaries, outside the scope of IHT.  It would be very simple to re-instate something similar, and not much harder to allow the funds to be transferred to a new trust with a smaller initial tax charge, but income tax payable on withdrawals.  It would probably be better to allow the first £x to go to the new trust without any initial charge, but overly complicated to try and link that to how much of the IHT band had been used, so something like a flat 25% on everything over £100k or £200k would seem reasonable to me.

Bostonerimus1

This question might be a bit niche, and I'm asking is elsewhere as well, but are overseas pensions owned by a UK resident currently treated similarly to UK pensions for IHT purposes? There's a tax treaty in place that recognizes the foreign pension for other tax purposes.

Albermarle

Triumph13 said:

Linton said:

zagfles said:

Albermarle said:

Triumph13 said:

[Deleted User] said:

Pat38493 said:

It's been stated here a few times that making pensions part of the estate would be legally very tricky and couldn't be done quickly.

For a DC pension, this would be trivial to do this and would be done as part of a normal Finance Act process.  

How it would be done for DB pensions is trickier.  Not in terms of the legislation but in terms (i) the political process for deciding the value of the pension to include in the estate, and (ii) for the payment of tax without upsetting the funding of some pension scheme (e.g. the assets no longer match the liabilities). 

As DB pensions are normally only inherited by the spouse, or minor children, I can't see any political party wanting to include them - unless they start being set up specifically as tax avoidance schemes somehow.

For DC it would be very simple to just have a flat tax charge at death, unless the funds are going to a spouse.  A 25% charge would mean subsequent basic rate withdrawals by the inheritors would have been charged 40% in total.  If you go higher than that, then a lot of people will just avoid it by withdrawing at 40% and gifting the proceeds, so that they avoid IHT if they live another seven years.

You ( and the previous poster)may well be right about it being simple to change DC pensions tax treatment on death.
However many commentators seem to think it would not be so easy, mainly I think due to having to change trust law.
I am not an expert so do not know the answer, but thought it was worth pointing out there are differing views

IHT is already charged on DC pensions in some circumstances eg contributions made when terminally ill. See IHTM17043 - Pensions: IHT charges: contributions made whilst in ill-health - HMRC internal manual - GOV.UK (www.gov.uk) 

That surely is under very different circumstances.  It is an anti tax avoidance measure to stop people putting money into pensions on their death bed, very similar to the 7 year limit for IHT on gifts except the limit is only 2 years.  IHT is applied on the assumption that the payment into the pension did not occur. So IHT is applied to the contributions, it is not a tax on the pension itself.

This is rather different to applying IHT to the whole of someone's pension which has been built up over many years and perhaps mostly already used up.

Bringing pensions into IHT would indeed be horribly complicated. Until the rules changed in 2014 though, the DC trust simply ended with the death of the pensioner and there was a 55% tax charge on remaining funds before they went to the nominated beneficiaries, outside the scope of IHT.  It would be very simple to re-instate something similar, and not much harder to allow the funds to be transferred to a new trust with a smaller initial tax charge, but income tax payable on withdrawals.  It would probably be better to allow the first £x to go to the new trust without any initial charge, but overly complicated to try and link that to how much of the IHT band had been used, so something like a flat 25% on everything over £100k or £200k would seem reasonable to me.

Would that not unfairly penalise people who were never likely to be liable for IHT?
For example they could be a surviving spouse with a £1M IHT allowance.
Have a house worth £200K, savings worth £100K and a pension pot of £500K. So even if the pot was in the estate they would not be liable for IHT, but would get hit with this flat rate tax on the majority of the pension they leave.

Bostonerimus1

[Deleted User] said:

Bostonerimus1 said:

This question might be a bit niche, and I'm asking is elsewhere as well, but are overseas pensions owned by a UK resident currently treated similarly to UK pensions for IHT purposes? There's a tax treaty in place that recognizes the foreign pension for other tax purposes.

The rules are the same. The key question is can you control what happens to your pension after death. If yes, it's in your estate. UK pensions generally get around that through letters of wishes. That may (or may not) be the case with something like a 401k.  Have a Google of s5(2) IHTA. There's bit in HMRC's IHT manuals that talk about this in the context of pensions and sets out HMRC's view of simple situations where it may or may not apply. To understand the UK position, you need to know the facts around the pension and what will (not might) happen on death. 

Thanks for the pointers. US 401k etc generally have nominated beneficiaries which can be challenged in exceptional circumstances, but they are legally binding so that might be an issue for UK IHT. If the beneficiaries are left blank then the pensions would be distributed according to the will or revocable trust in place and the executor or trustee has more leeway there. The UK's letter of wishes seems to be a strange document as it leaves room for the pension plan to get involved in the process in a way that seems very strange to my "American" sensibility.

Bostonerimus1

[Deleted User] said:

Bostonerimus1 said:

[Deleted User] said:

Bostonerimus1 said:

This question might be a bit niche, and I'm asking is elsewhere as well, but are overseas pensions owned by a UK resident currently treated similarly to UK pensions for IHT purposes? There's a tax treaty in place that recognizes the foreign pension for other tax purposes.

The rules are the same. The key question is can you control what happens to your pension after death. If yes, it's in your estate. UK pensions generally get around that through letters of wishes. That may (or may not) be the case with something like a 401k.  Have a Google of s5(2) IHTA. There's bit in HMRC's IHT manuals that talk about this in the context of pensions and sets out HMRC's view of simple situations where it may or may not apply. To understand the UK position, you need to know the facts around the pension and what will (not might) happen on death. 

Thanks for the pointers. US 401k etc generally have nominated beneficiaries which can be challenged in exceptional circumstances, but they are legally binding so that might be an issue for UK IHT. If the beneficiaries are left blank then the pensions would be distributed according to the will or revocable trust in place and the executor or trustee has more leeway there. The UK's letter of wishes seems to be a strange document as it leaves room for the pension plan to get involved in the process in a way that seems very strange to my "American" sensibility.

I agree, it is weird.  

I wonder if it's a hold over from the previous DB centric regime. It would be interesting to know how DC pensions came to be excluded from IHT and how this whole "letter of wishes" thing arose. Probably some trusts related thing. 

Bostonerimus1

[Deleted User] said:

Bostonerimus1 said:

[Deleted User] said:

Bostonerimus1 said:

This question might be a bit niche, and I'm asking is elsewhere as well, but are overseas pensions owned by a UK resident currently treated similarly to UK pensions for IHT purposes? There's a tax treaty in place that recognizes the foreign pension for other tax purposes.

The rules are the same. The key question is can you control what happens to your pension after death. If yes, it's in your estate. UK pensions generally get around that through letters of wishes. That may (or may not) be the case with something like a 401k.  Have a Google of s5(2) IHTA. There's bit in HMRC's IHT manuals that talk about this in the context of pensions and sets out HMRC's view of simple situations where it may or may not apply. To understand the UK position, you need to know the facts around the pension and what will (not might) happen on death. 

Thanks for the pointers. US 401k etc generally have nominated beneficiaries which can be challenged in exceptional circumstances, but they are legally binding so that might be an issue for UK IHT. If the beneficiaries are left blank then the pensions would be distributed according to the will or revocable trust in place and the executor or trustee has more leeway there. The UK's letter of wishes seems to be a strange document as it leaves room for the pension plan to get involved in the process in a way that seems very strange to my "American" sensibility.

I agree, it is weird.  

FYI I've been digging a bit and the issue comes down to SIPPs being discretionary trusts so the trustees decide who gets the money on death. US pensions and IRAs are not discretionary trusts and so do not qualify for UK IHT exemption even though the US/UK tax treaty recognizes IRAs as pensions for income tax and CGT purposes. That could be a big 40% fly in my ointment.

Albermarle

Bostonerimus1 said:

[Deleted User] said:

Bostonerimus1 said:

[Deleted User] said:

Bostonerimus1 said:

This question might be a bit niche, and I'm asking is elsewhere as well, but are overseas pensions owned by a UK resident currently treated similarly to UK pensions for IHT purposes? There's a tax treaty in place that recognizes the foreign pension for other tax purposes.

The rules are the same. The key question is can you control what happens to your pension after death. If yes, it's in your estate. UK pensions generally get around that through letters of wishes. That may (or may not) be the case with something like a 401k.  Have a Google of s5(2) IHTA. There's bit in HMRC's IHT manuals that talk about this in the context of pensions and sets out HMRC's view of simple situations where it may or may not apply. To understand the UK position, you need to know the facts around the pension and what will (not might) happen on death. 

Thanks for the pointers. US 401k etc generally have nominated beneficiaries which can be challenged in exceptional circumstances, but they are legally binding so that might be an issue for UK IHT. If the beneficiaries are left blank then the pensions would be distributed according to the will or revocable trust in place and the executor or trustee has more leeway there. The UK's letter of wishes seems to be a strange document as it leaves room for the pension plan to get involved in the process in a way that seems very strange to my "American" sensibility.

I agree, it is weird.  

FYI I've been digging a bit and the issue comes down to SIPPs being discretionary trusts so the trustees decide who gets the money on death. US pensions and IRAs are not discretionary trusts and so do not qualify for UK IHT exemption even though the US/UK tax treaty recognizes IRAs as pensions for income tax and CGT purposes. That could be a big 40% fly in my ointment.

If the speculation regarding changing tax treatment of pensions in the budget is even partly true, you will not be the only one with flies in the ointment !

Triumph13

Albermarle said:

Triumph13 said:

Linton said:

zagfles said:

Albermarle said:

Triumph13 said:

[Deleted User] said:

Pat38493 said:

It's been stated here a few times that making pensions part of the estate would be legally very tricky and couldn't be done quickly.

For a DC pension, this would be trivial to do this and would be done as part of a normal Finance Act process.  

How it would be done for DB pensions is trickier.  Not in terms of the legislation but in terms (i) the political process for deciding the value of the pension to include in the estate, and (ii) for the payment of tax without upsetting the funding of some pension scheme (e.g. the assets no longer match the liabilities). 

As DB pensions are normally only inherited by the spouse, or minor children, I can't see any political party wanting to include them - unless they start being set up specifically as tax avoidance schemes somehow.

For DC it would be very simple to just have a flat tax charge at death, unless the funds are going to a spouse.  A 25% charge would mean subsequent basic rate withdrawals by the inheritors would have been charged 40% in total.  If you go higher than that, then a lot of people will just avoid it by withdrawing at 40% and gifting the proceeds, so that they avoid IHT if they live another seven years.

You ( and the previous poster)may well be right about it being simple to change DC pensions tax treatment on death.
However many commentators seem to think it would not be so easy, mainly I think due to having to change trust law.
I am not an expert so do not know the answer, but thought it was worth pointing out there are differing views

IHT is already charged on DC pensions in some circumstances eg contributions made when terminally ill. See IHTM17043 - Pensions: IHT charges: contributions made whilst in ill-health - HMRC internal manual - GOV.UK (www.gov.uk) 

That surely is under very different circumstances.  It is an anti tax avoidance measure to stop people putting money into pensions on their death bed, very similar to the 7 year limit for IHT on gifts except the limit is only 2 years.  IHT is applied on the assumption that the payment into the pension did not occur. So IHT is applied to the contributions, it is not a tax on the pension itself.

This is rather different to applying IHT to the whole of someone's pension which has been built up over many years and perhaps mostly already used up.

Bringing pensions into IHT would indeed be horribly complicated. Until the rules changed in 2014 though, the DC trust simply ended with the death of the pensioner and there was a 55% tax charge on remaining funds before they went to the nominated beneficiaries, outside the scope of IHT.  It would be very simple to re-instate something similar, and not much harder to allow the funds to be transferred to a new trust with a smaller initial tax charge, but income tax payable on withdrawals.  It would probably be better to allow the first £x to go to the new trust without any initial charge, but overly complicated to try and link that to how much of the IHT band had been used, so something like a flat 25% on everything over £100k or £200k would seem reasonable to me.

Would that not unfairly penalise people who were never likely to be liable for IHT?
For example they could be a surviving spouse with a £1M IHT allowance.
Have a house worth £200K, savings worth £100K and a pension pot of £500K. So even if the pot was in the estate they would not be liable for IHT, but would get hit with this flat rate tax on the majority of the pension they leave.

Yes, but so did the old flat 55% charge.  In a perfect world, it would be nice to look at inheritance in the round.  To do that you'd include the value of all sizable gifts made pre death.  I'd even go further and say the more you yourself inherited, the less you should be able to pass on tax free.  That all gets very complicated indeed though.  A flat charge with a moderately sized nil band strikes me as a good compromise.