Up To 67% Tax On Pensions
14th November 2024
Rachel Reeves announced in the 2024 Autumn Budget that pensions will be subject to Inheritance Tax (IHT) from 6 April 2027. Pensions have always been a valuable IHT planning tool, but it seems not any more. However the actual tax charge could be up to 67% on the pension inherited, if not covered by a spousal exemption or the usual nil rate bands. In addition the change may also add up to an additional £140,000 IHT to the main estate liability.
This is because if an individual dies aged 75 or over, Income Tax is payable by beneficiaries when benefits are withdrawn from the pension. HMRC’s Case Study 5 in the budget notes (at Appendix A HERE) confirms that income tax and IHT could be due. This is best illustrated by an example.
Donald is a widower and dies aged 80 with a £1m pension. He has £2m of other assets and with transferable Nil Rate Bands (NRB) a potential total of £1m IHT free. The beneficiary of the pension pot will have to pay Income Tax on any withdrawals. Let’s assume worst case and the beneficiary is a 45% taxpayer and wants to draw out all the pension.
The Comparative Position Is As Follows:
The Residence NRB is restricted as the total estate is now £3m, so the £1m tax free reduces to £650,000. This adds an additional £140,000 to the overall IHT liability. The beneficiary of the pension receives £220,000 LESS than they would have on a pre 5 April 2027 death. The £1m pension has effectively had 67% taxation.
The rules do not come into play until April 2027, so could yet change and there may be no need to take any action just yet. However taking the 25% tax free amount, and gifting on during lifetime to avoid the beneficiary being taxed on that post death, would be one way to mitigate the increase. Assuming the tax free lump sum rules do not also change in future. In most cases a beneficiary would plan to take the pensions when liable at say 20% or 40%, so the Income Tax could be lower.
When the dust settles on this, and more details are released, more planning opportunities may arise. Watch this space.
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For more information or advice on IHT, Tax Planning and Pensions, contact your local Whitings LLP Team today.
Disclaimer - All information in this post was correct at time of writing.
