Budget 2024: pensions will be charged inheritance tax -Pension pots will be brought into inheritance tax (IHT) for the first time, removing some very favourable tax planning options from 2027
Chancellor Rachel Reeves confirmed at the Budget that pensions would come under the tax to ‘make the inheritance tax system fairer’.
This will remove the opportunity for individuals to use pensions as a vehicle for inheritance tax planning by bringing unspent pension pots and death benefits payable into the scope of inheritance tax from 6 April 2027, which will affect around 8% of estates each year.
It is also coupled with an extension of the freeze on IHT thresholds to 2030.
Pensions have been one of the most tax-efficient investments available to savers, with tax relief on personal contributions, tax-free growth and pension funds remaining outside of your estate for IHT on death. That means some retirees have prioritised using other savings and assets to fund retirement before their pensions.
Retirees and savers have 18 months to review their long-term plans. Pension withdrawals are subject to income tax, so some savers in drawdown will have an eye on the frozen £50,270 threshold at which point their overall income from all sources will be taxed at 40%.
It’s arguable that this consolidates the two tiers of the UK pension system, as the change removes one of the few advantages that defined contribution pensions had over the gold-plated final salary schemes that now exist largely just in the public sector.
This change will drag many more people into inheritance tax and there is less than two years to review current arrangements.
The generous treatment of pension death benefits has long been considered low hanging fruit for a government in search of cash.
Today that fruit has been plucked as pensions will now be made subject to inheritance tax. It’s a move that could prove complex and will need changes to trust law to make workable.
A much easier solution would have been a return of the so-called “death tax” that existed pre-Freedom and Choice and it is important that the industry engages with government during the consultation process to make sure unnecessary complication is not introduced.
The devil will be in the detail as with all tax reforms.
Where the deceased dies on or after their 75th birthday, withdrawals from the pension by beneficiaries is subject to income tax at their marginal rate, meaning that funds could be subject to an overall tax of up to 85% before reaching the beneficiary.
The published Budget documents do not mention this fact, but a consultation has been announced during which it will almost certainly be raised.
According to Treasury estimates, the measure is expected to raise around £3bn over three years, with an initial £640m in 2027-28, rising to £1.34bn in 2028-29 and £1.46bn in 2029-30.
The costings account for a behavioural response as individuals restructure their estates by increasing the rate at which they draw down their unused pensions, or by making greater use of other available reliefs and exemptions.
The government is removing with immediate effect the exclusion from the Overseas Transfer Charge for transfers to Qualifying Recognised Overseas Pension Schemes (QROPS) in the European Economic Area (EEA) or Gibraltar from 30 October 2024 to address the risk of individuals receiving double tax-free allowances.