New tax on inherited pensions would disrupt family plans, say advisers

A proposed new tax on pension death benefits would disrupt many families’ long-term inheritance plans, financial advisers warn.

The Government is considering tighter tax rules for pensions inherited from loved ones who die aged under 75 starting from April 2024, news of which took industry experts by surprise and prompted an outcry over the summer.

At present, beneficiaries either pay no tax on inherited pensions up to the deceased’s lifetime allowance limit if the owner dies before age 75, or their normal income tax rate if they are 75 or over.

 A tax on inherited pensions would disrupt family plans to pass on wealth, say experts

The Treasury is consulting on whether to levy income tax on withdrawals from pots inherited from younger savers too.

However, tax might still be avoided if beneficiaries take the cash as a lump sum outside of a pension.

Introducing a tougher regime risks sowing confusion and upsetting the plans of many people invested in drawdown schemes who want to pass on pension wealth to the next generation, according to industry pundits.

Some people have transferred out of valuable final salary pension schemes – which have benefits for surviving spouses but not children – primarily for that reason since the pension freedom reforms in 2015.

Research among around 200 financial advisers by Standard Life found 11 per cent support the proposed changes, 34 per cent are neutral, 39 per cent are opposed and 16 per cent are unsure.

But 92 per cent say the potentially tougher tax rules will impact clients’ financial plans, and 73 per cent think they should be delayed until after the next election.

Those not in favour offer reasons such as:

– Pension holders might take their tax-free cash lump sum earlier than they would ordinarily

– People have made financial plans based on assumptions about current death benefits

– Changes would undermine faith in the savings system.

Advisers who do support the changes believe:

– They would help harmonise tax treatment at whatever age the pension holder dies

– Savers would be encouraged to view their pension as a source of income rather than an asset to pass to loved ones.

Industry critics are concerned the new rules will create skewed incentives that could lead to poor decisions.

For example, beneficiaries might opt for a lump sum to avoid tax rather than income from an inherited pension, or people might take pensions sooner to avoid their loved ones paying income tax on it.

The mooted changes come after the £1,073,100 lifetime allowance, the total limit people can have in their pension pot without facing tax penalties, was ditched on 6 April. 

The old charges for breaching it are already gone. although the legislation itself will not change until April 2024.

However, Labour has said it would reinstate the lifetime allowance if it wins the next election.

Chris Hudson, retail advised managing director at Standard Life, says: ‘There have already been several unexpected changes to pension rules in the last year, creating upheaval for advisers as clients sought advice around what this meant for their finances and financial planning.

‘It’s therefore no surprise that many advisers do not support further changes to pension death benefits tax rules too, especially as this would affect a significant number of their clients’ plans.

‘Without proper planning there’s a risk of customer detriment. This is in addition to the speculation that measures around the scrapping of the lifetime allowance could be reversed if this Government was to lose power, which would likely cause further confusion and uncertainty.’

This post first appeared on Dailymail.co.uk