News & Blog

Government weighs abolishing income tax benefit for inherited pensions

22nd August 2023

The Government could be set to scrap a valuable income tax benefit relating to the inheritance of pensions.

The tax perk allows someone under the age of 75 to bequeath an uncrystallised (i.e., still invested) defined contribution (DC) pension pot without any income tax liability when the beneficiary draws income from the pot.

However, the proposal from HMRC recommends that from April, untouched pensions should no longer be exempt from income tax when inherited. This means anyone who inherits the pot would be liable to pay their marginal rate of income tax on whatever they draw down.

The announcement follows a consultation around the tax treatment of inherited pensions and relates to wider reforms around the lifetime allowance (LTA).

How does this affect your wealth?

Pensions are one of the most efficient ways to plan for inheritance, thanks largely to the generous income tax benefit which could now be axed.

The Government scrapped the pension LTA of £1,073,100 in April this year, making maximising pension tax benefits a much more attractive option for efficient tax and wealth planning. The removal of the LTA abolished 55% taxation on lump sums withdrawn over the LTA, plus a 25% charge on regular withdrawals.

However, the Labour Party has committed to reversing the change should it win the next General Election, which is currently pencilled in for December 2024, putting pension planning in doubt.

The latest figures from HMRC suggest an extra 50,000 families will begin to pay inheritance tax (IHT) by 2028. This is largely because of the ongoing frozen IHT threshold of £325,000 which has been in place over a decade, with an extra £175,000 allowance for main residence. Combined with a partner, the total tax-free allowance can be as much as £1 million.

Plans to abolish the pension inheritance income tax benefit have been recommended for April 2024, but are not set in stone as of yet and there has been no legislation forthcoming from the government. While it is important to be aware of the potential change, by no means should it totally change a wealth plan just yet.

The benefit also only impacts the pension pot of someone who dies under the age of 75. It is important to consider factors such as life expectancy, health and lifestyle as this benefit might not ultimately be that relevant.

Overall, it is key to be aware of the potential benefits and pitfalls in wealth and retirement planning, and to prepare your portfolio for the best outcome possible, no matter the inclinations of the government of the day.

If you would like to discuss the pensions inheritance issue further or anything else relating to your wealth planning, don’t hesitate to get in touch.

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