The Death Lottery, Double Taxation and the Leaky Tax Bucket

Aretnap

Grumpy_chap said:

Fluffysheep7 said:

Those beneficiaries losing in the Death Lottery i.e. the deceased dying after 75 will face the Double Taxation where a DC pension is taxed as both an Inheritance (asset) and as Income. Eyewatering maximum effective tax rate of 67% on inherited pension.

I think this only equalises the inherited pension with an inherited ISA.

HR tax payer above IHT threshold earns £100 extra.
Taken as salary that is subject to 40% IT plus 2% NI, so £58 received.
Place into ISA.
Pass on the next day, so IHT applies to the £58 at 40%.
Beneficiaries receive £34.80 after all taxes.

Another HR tax payer above IHT threshold earns £100 extra.
Pays into employer's pension, so no IT and no NI, so £100 in the pension.
Pass on the next day, so IHT applies to the £100 at 40%, meaning £60 is inherited.
Beneficiaries pay IT at marginal rate (could be lower or higher than 40%, but using 40% to make the comparison).  
Beneficiaries do not pay NI on the amount drawn from the inherited pension.
£60 less 40% IT.
Beneficiaries receive £36 after all taxes.

And in fact the beneficiary still gets a couple of very generous tax breaks:
 
(1) The money has had years or decades of tax free growth within the pension before they inherited it,  and it can continue to grow tax free if they don't withdraw it immediately, and
(2) The beneficiary can time withdrawals to coincide with points in their life where their annual income is low, and so minimise their income tax bill. Whereas if the person leaving the money had taken it as income and not out it into a pension, most of it would have come at a a time which their earnings were at their highest, and been subject to a high rate of income tax. 

So in most cases the beneficiary will still be significantly better if than they would have been had the money not gone into a pension in the first place. This might not be true if the beneficiary expects pay a high rate of tax for their entire life and can't really time withdrawals to minimise income tax. However if you're rich enough to pay higher rate tax your entire life, including in retirement, tax on your large inheritance is very much a first world problem

Albermarle

There seems to be conflicting info/opinion regarding beneficiaries paying income tax on withdrawals when the donor dies before 75.
Currently there is  zero income tax to pay, but some comments seem to indicate that this will change as part of the proposed budget IHT changes.
However I thought this no income tax under 75 rule has not been proposed to change ( yet anyway).
Have I missed something ?

Aretnap

Fluffysheep7 said:

Regardless of anything else I cannot think of any reason why when I die should affect the taxes my beneficiaries pay. Answers on a postcard to Rachel Reiver (a Borders joke). 

That's hardly Rachel Reeves' fault. You can blame George Osborne if you want to, though like a lot of things in the tax system it came about more or less by accident.

Until 2015 most people couldn't pass on pensions at all. It was compulsory to buy an annuity by the age of 75, most people bought them earlier, and once you bought your annuity there was no pot to pass on - just a monthly income that died with you (or your spouse for a joint annuity). If you died before you bought your annuity then you could pass the pot on tax free, but it wasn't a major route of tax avoidance because to pass anything on at all you had to make sure you died before you were 75, and not many people are going to do that to save their offspring a bit of tax. 

Enter George Osbourne who abolishes the requirement to buy an annuity and let's people draw down their pensions instead, or infamously withdraw the lot at once and buy a Lamborghini. An unintended consequence of that decision is that pensions suddenly become the most attractive tool for avoiding inheritance tax imaginable. Suddenly you could accumulate and pass on up to a million quid or whatever the lifetime allowance was at the time, without it ever being subject to any form of income, inheritance or capital gains tax.

That was to much even for George Osborne, so the "taxable as income if you die after 75" rule was hastily invented to plug the loophole and ensure that the money was at least taxed in some way at some point. Really it should have been applied regardless of when you died, but that would have left the beneficiaries of people who died younger worse of than they would have been under the old system, which was apparently a no-no.

GunJack

Aretnap said:

. Really it should have been applied regardless of when you died, 

Indeed, as if you died before 75 you aren't using it to fund your retirement...or at least only for those few years

MK62

GunJack said:

Aretnap said:

. Really it should have been applied regardless of when you died, 

Indeed, as if you died before 75 you aren't using it to fund your retirement...or at least only for those few years

Nobody is ever using what's left after they die to fund their retirement......

Aretnap

Fluffysheep7 said:

OK I've removed the difficult  moral and legal questions that will arise IRL and gotten my afters. I choose not to drink or smoke but like many want to give my children and grand children a bit of financial security. My plans for that have been seriously damaged. Regardless of anything else I cannot think of any reason why when I die should affect the taxes my beneficiaries pay. Answers on a postcard to Rachel Reiver (a Borders joke). Thought this would be a platform for moneysaving ideas or serious considered discussion. Personally I will give any inheritance over my available allowances to charities than any Reiver.

Final thought: leaving money to charity is a good and noble thing to do. But don't do it out of spite. Do it because the charity is dear to your heart and because your children and grandchildren are already more than adequately provided for.

Or at least, if you must do it out of spite, don't tell people how badly you want to help your children and grandchildren, then leave a load of money to the local cats home that you've never been that interested in before instead. If you'd rather not leave it to your children at all than pay a bit of tax in order to leave it to them, you can't have wanted to leave it to them that badly.

LHW99

There is a further point of potential complication raised in the first comment here (other points are also interesting)

https://www.moneymarketing.co.uk/news/changes-to-iht-and-pensions-risks-becoming-a-bureaucratic-nightmare/

The NRB for IHT has to be apportioned to gifts first, so at the very least, that is going to add a further layer of complexity for executors trying to sort out the estate, before they can work out the apportionment to any pension co.

Is this just a cunning way of encouraging people to name solicitors rather than relatives as executors

Fluffysheep7

Just have to laugh at people telling others what to do with their money. Thanks for the contributions that help my understanding. Excellent comparison with ISAs. However I can cash ISA tax free and create PET. My SIPP doesn't have that option.
Tax free inheritance through pensions may well have been an anomaly.
On reflection it is the retrospective aspect of the tax grab that causes anger. Yes, the changes come into effect in April 2027 but it affects a lifetime of saving and planning. The arbitrary 75 age thing still creates difficulties in planning. The cash free lump sum is a nonsense. The tax reliefs are a lottery in favour of highest rate tax payers. PETs, the remaining major tax avoidance device looks vulnerable.

Grumpy_chap

Fluffysheep7 said:

Just have to laugh at people telling others what to do with their money. Thanks for the contributions that help my understanding. Excellent comparison with ISAs. However I can cash ISA tax free and create PET. My SIPP doesn't have that option.
Tax free inheritance through pensions may well have been an anomaly.
On reflection it is the retrospective aspect of the tax grab that causes anger. Yes, the changes come into effect in April 2027 but it affects a lifetime of saving and planning. The arbitrary 75 age thing still creates difficulties in planning. The cash free lump sum is a nonsense. The tax reliefs are a lottery in favour of highest rate tax payers. PETs, the remaining major tax avoidance device looks vulnerable.

You can only cash the ISA tax free because the money was paid into the ISA after the appropriate rates of income tax and NI were paid.

You can draw the SIPP (assuming over minimum pension age = 55 currently), pay the appropriate rate of income tax, so making it equal to the ISA (in fact possibly slightly better as NI is still avoided).  You can then gift the funds and create PET.

Triumph13

And it's hardly a lifetime of planning when there was a 55% tax on pensions at death in 2015