The government appears to be backtracking on the ability to inherit pension pots tax-free, according to LCP.
A bundle of complex tax consultations published this week is believed to contain a potential bombshell for anyone expecting to inherit a pension pot free of income tax.
In 2015 then Chancellor George Osborne made taxation changes that meant it was possible to inherit a pension pot free of both inheritance tax and income tax where the person who died was under the age of 75.
But a consultation on changes to pension taxation could result in ordinary taxpayers having to pay income tax where they inherit an untouched pension pot.
Lifetime allowance and IHT
The consultation, launched earlier this week, is focused on the legal changes necessary to implement the abolition of the Lifetime Allowance (LTA) – the lifetime limit on tax-relieved pension pots.
Currently the LTA applies only to those with the largest pension pots, but the proposals unveiled this week would apply to anyone who inherited an untouched pension from a loved one who died under the age of 75 regardless of the size of the pot. If implemented, the change would take effect from April 2024.
More detail of the proposed legislation is to follow, the policy statement which accompanied yesterday’s announcement said: “Individuals will still be able to receive the benefits .. but the values will no longer be excluded from marginal rate income tax under [the income tax (Earnings and Pensions) Act 2003], with effect from 6 April 2024."
'Tax rise by the backdoor'
Steve Webb, partner at consultants LCP, said one advantage of the current system is that heirs can inherit money into a pension pot via a ‘beneficiary drawdown’ account where it remains invested, grows tax free, and can be drawn out free of income tax at any time.
"If the income tax privilege were to be withdrawn on this, the only alternative would be to take the inheritance as a cash lump sum, which would remain tax free. The recipient would then have to make difficult decisions about how to invest this money and how to manage it over time, as well as no longer benefiting from the pension ‘wrapper’ with its associated tax breaks and with the risk of inheritance tax on remaining funds after their own death.
Webb continued: “For the last eight years, people have known that if a loved one died under the age of 75 they could inherit an untouched pension pot free of all tax.
"The money could sit in a drawdown account, being invested and growing, and would be a source of tax free income whenever needed. This tax advantage risks being abolished by next April if these new proposals are implemented. It would be totally unacceptable to make such a big change ‘through the back door’. If ministers plan to remove this pension tax break they should announce their plans publicly and have them properly debated”.
