Wealthy families could face a double tax burden of up to 70.5 percent on inherited pensions

Wealthy families could face a double tax burden on inherited pensions of up to 70.5 percent under new rules announced in Wednesday’s budget.

The Chancellor plans to hold pensions liable inheritance tax (IHT) just like other assets such as real estate, savings and investments from April 2027.

But if a saver is over 75 at the time of death, beneficiaries still have to pay the normal income tax rate of 20 percent, 40 percent or 45 percent on pension withdrawals, which experts say amounts to double taxation. tax.

Speak with iGary Smith, financial planning partner at Evelyn Partners, said it was likely to affect a “significant number” of families, although it was difficult to pin down an exact figure.

IHT is generally paid at a rate of 40 per cent on the estate of someone who has died, but is only payable on amounts over £325,000. This threshold can also be significantly increased in many circumstances, and there are numerous exemptions – for example where money is left to a spouse.

The rate of income tax paid by someone who inherits a pension depends on the usual tax rate of the person receiving the pension.

If someone had a property worth £2 million and a pension of £4 million and chose to leave the pension to an additional rate taxpayer, they would first pay £1.6 IHT, giving them a pension of £ 2.4 million would be left. They would then pay the 45 per cent income tax rate on this £1.08 million, leaving them with £1.32 million – meaning 67 per cent has already been lost to tax.

But the pension scheme assets also mean £350,000 of the so-called zero interest rate band will be reduced to nothing. This effectively equates to a further £140,000 of IHT on the pension scheme, meaning an effective tax rate of 70.5 per cent.

In contrast, pension pots are currently treated generously by the tax authorities when people die, especially if they die before the age of 75, in which case they are generally inherited without any tax being paid on them.

As a result, they are widely used as a way to pass wealth from generation to generation, and are often spent last, if at all, by people whose assets could be affected by IHT.

But pensions are intended to fund retirement rather than leaving wealth to loved ones, and the government emphasized in the Budget earlier this week that it wants to end the practice.

Rachel Reeves said it is “removing the ability for individuals to use pensions as a means of IHT planning” by bringing unused pots within the scope of IHT.

It expects this to affect around 8 per cent of estates each year, raising £640 million in 2027-28, £1.34 billion the following year, and £1.46 billion in the third year of the new rules be force.

Experts, including Mr Smith, said they would not be surprised if this “double taxation option” changed as the proposal went through the consultation period.

Andrew Marr, managing partner at tax consultancy Forbes Dawson, said: “We have seen many tax measures introduced over the years, but for certain families the impact of this is huge and smacks of retrospective taxation.

“I use the world ‘retrospective’ because the individuals involved reasonably believed that pension funds would fall outside the scope of IHT and often made contributions where IHT protection was a consideration.

“And since these rules do not come into effect until April 6, 2027, they will have the unsavory impact of making old people aware that death after April 5, 2027 will have significant negative financial consequences for the beneficiaries of their estates.”

Mr Marr said there is “a remote chance” the government will make a U-turn before these rules come into force.

He added: “In the meantime, this really tips the balance in deciding whether 25 per cent tax-free lump sums should be deducted from pensions.”

Anyone who thinks he or she will leave pension funds unused should consider withdrawing and donating the lump sum, Mr Marr said.

He said: “Even if they don’t donate it, their beneficiaries would save a double layer of tax in the scheme when they die.”