HM Revenue & Customs is lining up a new stealth tax raid on the nation’s pension savings. It’s also making our pensions and inheritance tax system even more complex. Planning for the future is now impossible.
Remember the pensions lifetime allowance? It’s charged a brutal 55 percent tax on savers who did what the government had been encouraging them to do for years, and built up a large pot of money for their retirement.
The tax kicked in once savers had built up an entirely arbitrary £1,073,100 of pension, and took more than half the surplus.
Chancellor Jeremy Hunt announced he was abolishing it this year but now he looks set to replace it with something even worse, that will catch out people inheriting much smaller pension pots.
Worst, the proposal was sneaked out last week in a piece of HMRC small print that the Treasury was probably hoping nobody would notice.
Today, if you die before age 75, loved ones can inherit your unused pension free of tax if taken as income, provided it is under the lifetime allowance.
If you die after age 75, your beneficiaries may be liable to pay income tax on the money. Any withdrawals will be added to their total income from all sources for the year, and taxed at either 20, 40 or 45 percent.
In both cases, there is no inheritance tax as pensions are exempt, making them perfect for estate planning, or so millions thought.
Now here’s the change. HMRC has proposed charging income tax on inherited pensions where the policyholder dies BEFORE age 75.
This will apply to defined contribution company and personal pensions, rather than the dwindling number of workplace final salary schemes.
The worst part is this.
While the lifetime allowance only kicked in when pension pots topped £1.07million, income tax may be charged on every penny of withdrawals.
From April 6 next year, pension pots that were previously tax-free may now incur income tax, Gary Smith, partner in financial planning at wealth manager Evelyn Partners, warns.
As if that wasn’t bad enough, the Government is proposing two new lifetime limits where before there was only one.
The first is a Lump Sum Allowance set at £268,275. The second is a Lump Sum and Death Benefit Allowance set at £1,073,100. This covers both tax-free lump sums someone takes while alive and lump sums paid on death.
Confused? It only gets worse.
From next April, beneficiaries inheriting a pension pot have a choice. One option is to receive either a tax-free lump sum up to the lifetime allowance, Smith says. “The second is to inherit the pension in your own name with any future income withdrawals subject to income tax.”
Taking the tax-free lump sum may seem attractive but any unspent funds may then become liable to inheritance tax at 40 percent when the recipient dies, Smith warns.
Basic rate taxpayers may do better taking the income, as they would only hand 20 per cent of any withdrawals to HMRC. “For those who pay 40 per cent or 45 percent income tax, the lump sum option may be more beneficial.
This abject proposal throws up a host of other questions including this one. If someone has already inherited a pension from a relative who died before age 75, will withdrawals made after April 6 next year be subject to income tax?
We don’t know. I’m not sure HMRC does.
READ MORE: Death tax raid plan for pension pots is ‘ticking time bomb’
