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.

Tommyrot

Is there any update on the situation? I believe I saw an article indicating the pension recipient would have to assess and pay the tax due on the pension instead of the pension provider.

i understand that beneficiaries will pay tax at their marginal rate on funds drawn from the residual pension after funds have been distributed.

How will the IHT due on the pension fund be paid? Will it be paid by the estate direct to HMRC as a lump sum drawn from the fund free of income tax or will the estate or beneficiaries be required to pay income tax at their marginal rate marginal rate of the beneficiaries?

If the latter the repercussions would be horrendous. The pension pot could be the most readily available source of liquidity to pay IHT within the available window but is likely to leave the beneficiaries with unpaid tax liabilities that would take years to clear. It would also amount to double taxation.

Applying IHT to pension pots will push many estates into an IHT liability that they otherwise have escaped. The process will inevitably be highly complex.

i only hope I live long enough to spend my pot.

Albermarle

Tommyrot said:

Is there any update on the situation? I believe I saw an article indicating the pension recipient would have to assess and pay the tax due on the pension instead of the pension provider.

i understand that beneficiaries will pay tax at their marginal rate on funds drawn from the residual pension after funds have been distributed.

How will the IHT due on the pension fund be paid? Will it be paid by the estate direct to HMRC as a lump sum drawn from the fund free of income tax or will the estate or beneficiaries be required to pay income tax at their marginal rate marginal rate of the beneficiaries?

If the latter the repercussions would be horrendous. The pension pot could be the most readily available source of liquidity to pay IHT within the available window but is likely to leave the beneficiaries with unpaid tax liabilities that would take years to clear. It would also amount to double taxation.

Applying IHT to pension pots will push many estates into an IHT liability that they otherwise have escaped. The process will inevitably be highly complex.

i only hope I live long enough to spend my pot.

That is the reason why the legislation is being changed. Pension pots ( partly funded by tax relief) were more and more being used by relatively well off people to avoid IHT.

AIUI due to the potential admin complications, there will be clear ( hopefully) guidance to Executors of the correct procedures on Gov.UK before it all kicks in.
However it will of course be more complicated than it is now, and could be a lot of extra lucrative work for professionals working in this area.

Albermarle

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.

The 'expert' is wrong. There are often mistakes on this show.

There has been no announcement on the Age 75 rule, but that does not mean there will not be one at some point.

Marcon

Tommyrot said:

Is there any update on the situation? 

https://www.gov.uk/government/consultations/inheritance-tax-on-pensions-liability-reporting-and-payment/outcome/inheritance-tax-on-pensions-liability-reporting-and-payment-summary-of-responses

SVaz

I found this segment mildly amusing: 

“The government has also announced that it will introduce a new digitalised Inheritance Tax service in the 2027 to 2028 tax year, which will make submitting information and paying tax simpler and quicker. However, at the present time neither the Pensions Dashboard nor ‘Tell us Once’ service could provide solutions or additional support for PSAs or PRs”

If anyone believes this will be up and running by then, I have a bridge to sell them 😉

This also caught my eye :

“From 6 April 2027 all death in service benefits payable from registered pension schemes will be out of scope of Inheritance Tax, regardless of whether the scheme is discretionary or non-discretionary. This means that there will be consistent treatment of death in service benefits between discretionary and non-discretionary schemes.”

I think they realised how unfair it would be to tax DiS benefits but not Life insurance payouts that are written in trust.