Only tax inherited pensions worth more than £90k, Reeves urged
The Investing and Saving Alliance (Tisa), a lobby group representing hundreds of financial services companies, has urged the Chancellor to rethink plans to bring pensions into the inheritance tax system.
In her maiden Budget, Rachel Reeves announced unspent pensions would be brought into the scope for inheritance tax from April 2027. The family of someone dying over the age of 75 would potentially see their inheritance reduced by death duties at 40pc, and then pay income tax on the remainder.
In a report produced with Oxford Economics, Tisa suggested alternative ways to tax pensions and raise similar amounts of revenue without placing an 'additional burden' on grieving families.
Under one proposal, families would pay no tax if the deceased's pension pots add up to less than £90,000.
Over this threshold, the beneficiaries would pay income tax at their 'marginal' or highest rate. Dependants would be able to take the inherited pension as income over time, while non-dependants would have to take it as a lump sum.
Currently, pensions are inherited entirely tax-free if the deceased is under the age of 75 – up to a limit of £1.07m.
Under Tisa's second proposal, families would pay a flat tax rate on all unused pension funds over a certain threshold. It was suggested this could be a 25pc charge on pensions worth more than £150,000, 30pc over £200,000, or 35pc over £250,000.
According to Oxford Economics' modelling, both proposals would raise about as much as the Government's inheritance tax raid. The reforms are expected to generate just over £1bn in revenue in the first year and £2bn annually after that.
Tom Selby, of stockbroker AJ Bell, said inheritance tax was 'arguably the most complex, time-consuming way' of taxing pensions.
He added: 'If the Treasury refuses to budge, it will be the bereaved families of people who have saved diligently all their lives who will be left to handle this administrative nightmare.'
Under current plans, pensions will be included as part of an individual's estate for inheritance tax purposes from April 2027.
The tax is charged at 40pc on the part of an estate worth more than £325,000 – or £500,000 if a homeowner leaves their main property to their children. Couples can share their allowances so they can potentially pass on £1m.
The measures were announced in the Chancellor's October Budget, and a technical consultation was launched at the end of last year.
But wealth managers and pension providers warn the new system could lead to widespread delays, with grieving families paying inheritance tax late through no fault of their own, and subsequently being hit with penalties by the taxman.
Inheritance tax must be paid within six months, otherwise HM Revenue and Customs (HMRC) will start charging interest at 8.25pc.
Andrew Tully, of the investment platform Nucleus, said: 'This complex process will cause bereaved families confusion and stress at a difficult time, and doesn't fit well with the support firms may want to provide people who are likely to be vulnerable following the death of a loved one.
'Most importantly, it will significantly slow down the payment of death benefits, and mean many beneficiaries will lose out financially after inheritance tax late payment interest penalties are levied.'
Experts also warned the inheritance tax raid could ensnare far more families than predicted. According to government estimates, 10,500 estates which would previously have avoided the charge will now pay inheritance tax in 2027-28 because of the pension reforms.
But the number of families caught out is likely to rise over the years due to rising house prices and frozen inheritance tax thresholds.
Tisa's Renny Biggins said: 'The two alternatives we've set out offer a simple and proportionate approach, taxing beneficiaries on what they receive in a way that still discourages the use of pensions as a wealth transfer vehicle, but does not pull unused pensions into the complex inheritance tax system.'
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