Brits may have to pay income tax when inheriting an untouched pension pot a government consultation has revealed.
Currently if a loved one dies before the age of 75, their pension can be inherited tax-free if taken as income.
However, new rules being considered by the government could mean that a recipient of an untouched inherited pension would see the whole amount be taxed if their loved one died before the age of 75 and they chose to access the pot as income.
This proposal is part of the governments aim to abolish the lifetime allowance (LTA) and if implemented would take effect from April 2024.
The advantage of the current system is that heirs can inherit the money into a pension pot, such as a ‘beneficiary drawdown’ account where it remains invested and grows tax free.
If the income tax privilege were to be withdrawn the only alternative would be for the heir to take the inheritance as a cash lump sum which may cause them to struggle when not knowing how to invest it correctly.
Two new lifetime limits would also be created as part of the consultation, comprising a ‘lump sum allowance’ set at £268,275 ($345,055, €310,072) a quarter of the current LTA allowance.
As well as a ‘lump sum and death benefit allowance’ set at £1,073,100 which incorporates tax-free lump sums someone takes while alive and lump sums paid on death.
If a person was to take an inherited pension as a lump sum and it was within the limit of £1,073,100 it would remain tax-free.
Steve Webb, partner at consultants LCP, said: “For the last eight years, people have known that if a loved one died under the age of 75 they could inherit an untouched pension pot free of all tax. The money could sit in a drawdown account, being invested and growing, and would be a source of tax free income whenever needed.
“This tax advantage risks being abolished by next April if these new proposals are implemented. It would be totally unacceptable to make such a big change ‘through the back door’. If Ministers plan to remove this pension tax break they should announce their plans publicly and have them properly debated.”
Tom Selby, head of retirement policy at AJ Bell, commented: “The decision to scrap the lifetime allowance had the potential to be a hugely positive step in making pensions simpler for millions of people and ditching a significant disincentive to save for their financial future. It will still provide a big boost for pension savers, however the government is at risk of tying itself in knots by creating two new lifetime limits for pensions.
“But, bizarrely, not content with this confusion, the government is considering going further and adding even more complexity to the new rules by creating a new pension ‘death tax’ where someone dies before age 75.
“The rules are still to be finalised in legislation and at this stage it is not yet 100% clear exactly how pension assets will be treated on death. Although the government’s briefing note and subsequent newsletter suggests the introduction of the new ‘death tax’ for those who die before 75, this isn’t specified in the draft legislation tabled.
“This needs to be clarified urgently so pension savers can make informed decisions based on the planned rules, albeit those rules could yet be re-written if a future government changes pension legislation again.”
