Income tax on inherited pensions - MLMS error?

priorslee

Martin's Money Show talked about how beneficiaries are currently subject to income tax on any pension funds inherited where someone dies after age 75. 
This led to a discussion about how from 2027 these payments could also be subject to IHT as well (ie double-taxation).

Martin then asked whether the age 75 cut-off still applies after the changes in 2027, to which the expert replied 'based on what we know already' ... 'the age limit will be gone, so it's everybody', implying that ALL beneficiaries will be subject to income tax at their marginal rate on inherited pension funds.

I've been searching for sources to confirm this, but can't find this covered anywhere. 
Does anyone know if this is correct? 

LHW99

Suspect it's all speculation. I think the consultation has only just closed.

DRS1

As far as I am aware they are only changing IHT not income tax so 75 is still relevant for income tax.  It is not relevant for IHT.

Marcon

LHW99 said:

Suspect it's all speculation. I think the consultation has only just closed.

Correct - closed on 22 January.

Worth reading Example 1 which follows immediately after 2.10 in the consultation document to give an idea of what could happen: https://www.gov.uk/government/consultations/inheritance-tax-on-pensions-liability-reporting-and-payment/technical-consultation-inheritance-tax-on-pensions-liability-reporting-and-payment - reproduced below for those who don't fancy a squint at the whole thing:

2.9. Making the PRs liable for payment of any Inheritance Tax due on a pension can create liquidity challenges if the PRs themselves do not have access to the relevant pension funds. The PRs of the estate are often not the actual beneficiaries of the pension, and so will have to use other assets in the estate to pay the Inheritance Tax due on the pension element. In these cases, PRs can then seek reimbursement directly from the actual beneficiary of the pension funds or death benefits.  

2.10. If the beneficiary draws down the inherited pension to reimburse the PRs for Inheritance Tax, they may then also be liable to pay Income Tax on those funds at their own marginal rate. This can lead to a situation where an additional Income Tax charge arises on funds which have already been subject to Inheritance Tax.  

Example 1  

An estate is made up of a free estate valued at £1 million and a pension fund valued at £100,000. It benefits from the £325,000 Inheritance Tax nil-rate band. No other nil-rate bands, exemptions or reliefs apply. The pension fund passes to Judy. The Inheritance Tax bill for the free estate (the £1 million) is £281,818.18. The Inheritance Tax bill for the pension fund (the £100,000) is £28,181.82. The PRs pay the whole of the £310,000 Inheritance Tax due, but are entitled to be reimbursed the £28,181.82 from Judy. Judy’s marginal rate of Income Tax is 40%. Judy therefore has to withdraw sufficient funds from her pension so that she has £28,181.82 to pay to the PR after paying Income Tax at her marginal rate.

As her marginal rate is 40%, she has to withdraw £46,969.70 from the pension fund (£46,969.70 income - £18,787.88 Income Tax at marginal rate = £28,181.82 received). So, to settle her Inheritance Tax liability, Judy has had to withdraw much more from her pension. Judy has paid £46,969.70 in Inheritance Tax and Income Tax  on the pension fund and will still be liable for Income Tax at her marginal rate when accessing the £53,030.30 remaining in the pension.  

priorslee

Thanks for the comments.

Example 1 doesn't quote ages and para 2.10 says 'if the beneficiary draws down the inherited pension to reimburse the PRs for Inheritance Tax, they MAY then also be liable to pay Income Tax on those funds at their own marginal rate.' So difficult to draw any conclusions.

Looking at the examples in Annex A, the only ones which mention income tax are those where death occurs at ages over 75. Hopefully this is a strong pointer that the over 75 regime isn't being extended to all ages.

I'm in agreement with LHW99, that it must be speculation at this point (in which case saying it on MLMS probably isn't  wise!)

af1963

That "example 1" is in a section discussing the *current* position, where PRs pay the tax bill and claim it back from the beneficiary of a pension that is liable for IHT.  (only applies to a non-discretionary pension - which is fairly uncommon)

Under the proposed new system, all pensions would potentially be liable for IHT but Pension Scheme Administrators would be responsible for reporting and paying any IHT due on the pension benefits. That avoids the "money to pay the IHT" problem in example 1.

Doesn't affect the OP's question though - there's nothing in the announced proposals that changes the rules for income tax on inherited pensions.