A new report has suggested a rewriting of the inheritance tax (IHT) rules which currently treat pensions “extremely favourably”.
Under proposals put forward by the Institute for Fiscal Studies (IFS), pension pots should be included as part of the taxpaying deceased’s estate for IHT purposes.
They also suggested the basic rate of income tax should be charged on the inherited pension no matter the age that the deceased passed away, scrapping the current pension IHT breaks that exist for those who died before 75.
This would see somebody inheriting a £100,000 pension outside of the nil-rate bands potentially paying up to £60,000 in tax: 40% IHT and 20% basic rate income tax on the pension pot.
Justifying their proposals, the IFS said pensions are “increasingly used as a vehicle for bequests”:
“Growth in defined contribution pensions along with the introduction of ‘pension freedoms’ would lead to more pension wealth being bequeathed at death even if people did not respond to the strong tax incentives to use pensions for bequests. Pensions and wealth-management professionals are fully aware of these tax benefits which, increasingly, are also being reported in the press. If nothing changes, more people will respond to the incentives the tax system creates.”
They also suggested the change would “raise revenue and remove the perverse incentive to avoid using a pension to fund retirement”:
“Short-term revenue would be limited because few of those dying today are bequeathing pension pots. But if the generation benefiting from pension freedoms – those retiring after April 2015 – were to die with their full pension pots intact, we estimate that it would raise the equivalent of £1.9 billion a year (in today’s terms) in extra inheritance tax revenue.
This increase would be substantial, representing an increase of around a quarter in the scope and yield of inheritance tax. The yield is very sensitive to the extent to which pensions will be run down before death: were half of current pensions intact at death, the yield would fall to £0.9 billion.”
They added reforms should be announced “as swiftly as practical”, as well as deeming some retrospective taxation “inevitable” following the introduction of new rules.
Read the full report here.