Inheritance tax on pension funds

Bostonerimus1

I've never really understood why pensions don't get counted towards IHT and the whole "discretionary trust" thing with "letters of wishes" is bizarre. Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold. For comparison that's what happens in the US, DC pensions are included in the value of the estate, but the federal nil rate band for estate tax is $13.6M per individual.

Bostonerimus1

[Deleted User] said:

Bostonerimus1 said:

I've never really understood why pensions don't get counted towards IHT and the whole "discretionary trust" thing with "letters of wishes" is bizarre. Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold. For comparison that's what happens in the US, DC pensions are included in the value of the estate, but the federal nil rate band for estate tax is $13.6M per individual.

It wasn't really an issue in 1986 when IHT was introduced.  There were RACs but personal pensions only came in a couple of years later.  But then people had to buy annuities so it was only an issue (in terms of there being a pot left) if you died young. Having discretion meant to no IHT so that's the way things went.

Getting rid of the annuity requirements, the behavioural impact of no IHT, the relative increase in DC values compared with the IHT threshold, and the removal of the LTA means that it has become much more of an issue today.  But no individual benefits from having the pension in their estate and so politicians have been too scared to do anything about it (or were never briefed it was an issue - inheritance tax was never mentioned in the 2002 pension simplication ConDoc for example).

You ask "Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold".  What's it trying to achieve?  In this example, people with small pension pots and large assets will be way better off.  So as a revenue raising measure it doesn't sound good.  It's also not simple (how many thresholds, how many rates, how do they apply to DB schemes where the kids or an unmarried partner gets a pension).  What's the effective rate when income tax is due on the pension?  Is a 67% marginal tax rate too high?  

Obviously lots of details, I was just suggesting to raise the threshold estate value where the IHT takes effect and include pensions in that number. Ihe income tax on the inherited DC accumulation would just be paid by the beneficiaries. It looks like this is an area that needs a lot of updating as there's a big hang over form the old regime where DC pensions weren't a thing, just DBs and annuities.

Albermarle

Bostonerimus1 said:

[Deleted User] said:

Bostonerimus1 said:

I've never really understood why pensions don't get counted towards IHT and the whole "discretionary trust" thing with "letters of wishes" is bizarre. Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold. For comparison that's what happens in the US, DC pensions are included in the value of the estate, but the federal nil rate band for estate tax is $13.6M per individual.

It wasn't really an issue in 1986 when IHT was introduced.  There were RACs but personal pensions only came in a couple of years later.  But then people had to buy annuities so it was only an issue (in terms of there being a pot left) if you died young. Having discretion meant to no IHT so that's the way things went.

Getting rid of the annuity requirements, the behavioural impact of no IHT, the relative increase in DC values compared with the IHT threshold, and the removal of the LTA means that it has become much more of an issue today.  But no individual benefits from having the pension in their estate and so politicians have been too scared to do anything about it (or were never briefed it was an issue - inheritance tax was never mentioned in the 2002 pension simplication ConDoc for example).

You ask "Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold".  What's it trying to achieve?  In this example, people with small pension pots and large assets will be way better off.  So as a revenue raising measure it doesn't sound good.  It's also not simple (how many thresholds, how many rates, how do they apply to DB schemes where the kids or an unmarried partner gets a pension).  What's the effective rate when income tax is due on the pension?  Is a 67% marginal tax rate too high?  

Obviously lots of details, I was just suggesting to raise the threshold estate value where the IHT takes effect and include pensions in that number. Ihe income tax on the inherited DC accumulation would just be paid by the beneficiaries. It looks like this is an area that needs a lot of updating as there's a big hang over form the old regime where DC pensions weren't a thing, just DBs and annuities.

However someone with all their assets in property, non pension investments etc, but no unused pension fund ( such as with a DB pension) could end up paying more IHT than now.
Always winners and losers whatever is done.
Probably the key rational argument behind any changes ( if there are any)  is that pensions are encouraged by the Govt through tax benefits, so you can have a nice pension/retirement and be spending money and not asking for handouts when retired. A pension ( bolstered by Govt tax benefits ) should not be a  way of passing on family wealth tax free.  
The technicalities ( and the potential pain for some ) are a different matter, but that is I presume the logic behind any change. 

Grumpy_chap

Bostonerimus1 said:

Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold. 

AIUI, my current DC pension is in a trust and can't now be "un-trusted" so is always outside my Estate unless the pension has made payments to me in accordance with the rules of the trust.  Those rules prohibit early withdrawal of the funds and also restrict the funds to be paid to me only 

Therefore, I think any such change to bring pensions into the Estate would require the rules of existing trusts to be changed and / or would have to be introduced in such a way that existing pensions are ring-fenced under the current trust rules and outside of Estate while new pensions would be accrued in a new form of pension vehicle that sits outside the constraints of a trust.  I am not sure how easily the rules on early access could be applied in  the same way.  Also, if the pension fund is just in the Estate so always mine for me to do with as I wish, what is to stop me from drawing the funds early and / or reallocating (gifting capital) so that a good proportion is drawn in my wife's tax allowance rather than allow my allowance tips into higher rate?

There could be more complex issues to make such a change.  For that reason, it seems outside the scope of a single budget but would require a commission first and several years for resulting legislation change to proceed.

Bostonerimus1

Grumpy_chap said:

Bostonerimus1 said:

Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold. 

AIUI, my current DC pension is in a trust and can't now be "un-trusted" so is always outside my Estate unless the pension has made payments to me in accordance with the rules of the trust.  Those rules prohibit early withdrawal of the funds and also restrict the funds to be paid to me only 

Therefore, I think any such change to bring pensions into the Estate would require the rules of existing trusts to be changed and / or would have to be introduced in such a way that existing pensions are ring-fenced under the current trust rules and outside of Estate while new pensions would be accrued in a new form of pension vehicle that sits outside the constraints of a trust.  I am not sure how easily the rules on early access could be applied in  the same way.  Also, if the pension fund is just in the Estate so always mine for me to do with as I wish, what is to stop me from drawing the funds early and / or reallocating (gifting capital) so that a good proportion is drawn in my wife's tax allowance rather than allow my allowance tips into higher rate?

There could be more complex issues to make such a change.  For that reason, it seems outside the scope of a single budget but would require a commission first and several years for resulting legislation change to proceed.

When trusts are involved it's always complicated. It seems to me that the current exclusion of DC pensions from a person's estate originates in the previous pension regime where DB and annuities prevailed and having a "balance" in a pension account at death wasn't a thing other than maybe some death benefit payout. Making UK DC pensions discretionary trusts allowed them to stay out of an estate, but the thinking was probably that the balance would largely have been used for retirement income. Pensions just weren't a vehicle for passing on wealth. That's obviously changed so maybe the laws around their taxation also need to be updated.

For former UK expats who return to the UK with large foreign DC pension balances that are not discretionary trusts this means that those pensions will be counted when valuing their estate and the current IHT threshold means that they will be paying quite a bit in IHT just because of the structure of the DC pensions and nothing to do with how they are used. I know one former UK  expat who is looking at a very large IHT bill. His solution has been to give lots away to his children, but obviously that's increased his income tax bill.

Albermarle

Grumpy_chap said:

Bostonerimus1 said:

Why not just increase the nil rate band by 500k or 1M say and include pensions in the estate and then progressively tax amount over that threshold. 

AIUI, my current DC pension is in a trust and can't now be "un-trusted" so is always outside my Estate unless the pension has made payments to me in accordance with the rules of the trust.  Those rules prohibit early withdrawal of the funds and also restrict the funds to be paid to me only 

Therefore, I think any such change to bring pensions into the Estate would require the rules of existing trusts to be changed and / or would have to be introduced in such a way that existing pensions are ring-fenced under the current trust rules and outside of Estate while new pensions would be accrued in a new form of pension vehicle that sits outside the constraints of a trust.  I am not sure how easily the rules on early access could be applied in  the same way.  Also, if the pension fund is just in the Estate so always mine for me to do with as I wish, what is to stop me from drawing the funds early and / or reallocating (gifting capital) so that a good proportion is drawn in my wife's tax allowance rather than allow my allowance tips into higher rate?

There could be more complex issues to make such a change.  For that reason, it seems outside the scope of a single budget but would require a commission first and several years for resulting legislation change to proceed.

From some  posts in this thread and others, it seems to be that the complicated trust issue would be difficult to overcome, and therefore difficult to put an unused DC pot in your estate.
However there seems to be other things that could be done, like having a separate tax charge on the pot on death, and other possible suggestions that may or may not be feasible. 

MetaPhysical

Golly, I think all these things need a year or two of thorough minute analysis in case of serious unintended consequences to affected individuals as highlighted in this thread   All the options open to the government seem riddled with them.  Even the marginal rate band tinkering leads to severe unintended consequences and double taxation as indeed does meddling with the PCLS and tax free cash.  People had planned for that TFC to pay off mortgages.

As an immediate change I think she'll just tinker with the annual allowances - it seems the simplest thing to do.

LHW99

Probably the key rational argument behind any changes ( if there are any)  is that pensions are encouraged by the Govt through tax benefits, so you can have a nice pension/retirement and be spending money and not asking for handouts when retired. A pension ( bolstered by Govt tax benefits ) should not be a  way of passing on family wealth tax free.

And of course, no one knows their personal life expectancy. We are encouraged to make sure we have enough to support our lifestyle (be that basic, moderate or luxury), which is very likely to mean that hopefully few people will outlive their pot income, and currently know that what's left if any remains to pass on..

If IHT (or another) is levied at a significant rate on residual money, I suspect people will start looking for ways to avoid money being left in the pot, possibly by not putting as much into pensions, and risking the consequences.

Pat38493

LHW99 said:

Probably the key rational argument behind any changes ( if there are any)  is that pensions are encouraged by the Govt through tax benefits, so you can have a nice pension/retirement and be spending money and not asking for handouts when retired. A pension ( bolstered by Govt tax benefits ) should not be a  way of passing on family wealth tax free.

And of course, no one knows their personal life expectancy. We are encouraged to make sure we have enough to support our lifestyle (be that basic, moderate or luxury), which is very likely to mean that hopefully few people will outlive their pot income, and currently know that what's left if any remains to pass on..

If IHT (or another) is levied at a significant rate on residual money, I suspect people will start looking for ways to avoid money being left in the pot, possibly by not putting as much into pensions, and risking the consequences.

What proportion of people contribute to their pension with the sole intention of bypassing inheritance tax today?  I doubt it’s a significant proportion of people.  

artyboy

Pat38493 said:

LHW99 said:

Probably the key rational argument behind any changes ( if there are any)  is that pensions are encouraged by the Govt through tax benefits, so you can have a nice pension/retirement and be spending money and not asking for handouts when retired. A pension ( bolstered by Govt tax benefits ) should not be a  way of passing on family wealth tax free.

And of course, no one knows their personal life expectancy. We are encouraged to make sure we have enough to support our lifestyle (be that basic, moderate or luxury), which is very likely to mean that hopefully few people will outlive their pot income, and currently know that what's left if any remains to pass on..

If IHT (or another) is levied at a significant rate on residual money, I suspect people will start looking for ways to avoid money being left in the pot, possibly by not putting as much into pensions, and risking the consequences.

What proportion of people contribute to their pension with the sole intention of bypassing inheritance tax today?  I doubt it’s a significant proportion of people.  

Maybe not, but given the historic move from DB to DC pension schemes, and the corresponding shift of investment risk to the individual, the ability to leave any residual amounts free of IHT is a bit of a compensatory perk for a system that is inferior to what came before...